Wrong Discussion

The discussion in the world’s financial press regarding Fed decision making is framed inappropriately. The discussion is about what is next and how markets will react.

The insanity is that this dialogue passes the sobriety test. Most sit in the theatre, lemming-like, riveted to the action; instead of waiting for the next act, they should demand a refund.


Background:  From a recent sketch by George Will: “The Fed has become the model of applied progressivism, under which power flows to clever regulators who operate independent of political control. The Fed is, however, a creation of Congress, which may not forever refrain from putting a bridle and snaffle on a Fed that increasingly allocates credit, wealth and opportunity.” 

The tragedy is that Bernanke and others think they can “out figure” the free market, that they, the anointed, have been selected by the market god to efficiently direct resources. 


Key to today’s sketch is that this tragedy is expanded by the effort, any effort to communicate with, to embrace the FI market crowd.

As a central banker you must never, ever put yourself in a situation where you feel obliged to engage. You are then held hostage to what is almost always a reaction in the extreme – this is as true of a lynch mob or the Bastille as it is of this bunch.

So when our activist Fed chair hints of an ease in QE, rates erupt; he then feels forced to say he will continue with QE, and so on; thus additions are made to this house of cards before our very eyes.

Observers feel betrayed, pouting because in their view the Fed double-crossed them on Sep/18. The Fed’s credibility “is now shredded,” whines one street economist. “They can’t be trusted.”

KC Fed pres George warns that the Fed’s message has been muddled and the Fed has surrendered at least some of its credibility. The Fed, “…will have to think about the challenges that come with issues of credibility….”  “The actions at this meeting, and the expectations that have been set relative to how markets were thinking about this, created confusion, created a disconnect.”

Of course; there could be no other result.

There is nothing sinister here. There is perhaps no intent to deceive; policy makers are simply not trained for the task at hand. But it is “the task at hand” that is the problem.

Robert Craven
 

House of Cards

Recent key US economic prints telegraphed a wilt for Q3; and equities erupt. What?  To regular folk this appears to be the theater of the absurd. They’re right.

Many of us understand it is something else - a house of cards.

Recall the normal cycle of expansion, contraction; then a re-birthing and then expansion anew – all very healthy.  Planners have aborted that process.

Some are beginning to catch on (after trashing a system that worked very well before they came along) that to interfere with the natural pricing mechanism will backfire. For example, some Fed staffers are worried about the chasm between equity prices and economic reality; some staffers in fact very close to Bernanke. This is why QE will be eased despite a “surprisingly” slower Q3 - because of the threat of an abscess.

Bernanke has unplugged the normal pricing mechanism. Thus the equity market takes off after weak data because one man at the Fed says it should. In the meantime, another sector, say normal, everyday retired folks who’ve got to keep the little they have safe and sound, get knifed because planners have decided that fate for them.

Background:  We know from the works of Friedman, Taylor, von Mises, Rueff, and others that rule-based policy making creates more prosperity than discretionary policy making. For example, US economic performance during periods of rule-based policy making has eclipsed periods of discretionary policy making; that is, the 60’s – 70’s was discretionary, then ‘85 – 2003, rule-based; and then  2003 to present - discretionary. Performance during the ‘85- 2003 period blew away the other two.

Planners at the Fed have rigged the system. They, the anointed, have selected certain sectors of the economy to fire, and others, to extinguish. This practice – the distribution of favors - is immoral.

For an anchor, recall the incestuous relationship between the Fed and the banks. This reality explains a lot (and why most of these guys who hatched the ’08 debacle are not under house arrest beats us). As fund manager Seth Klarman put it recently, when referring to Bernanke’s Fed, “What kind of ….entity cajoles savers to spend…tricks its citizens into paying higher and higher prices to buy stocks…and drives the return on retirees’ savings to zero… in order to rescue poorly managed banks?”

Guess.  And it can come to no good; meaning that what could have been a vigorous recovery will be instead, anemic; all due to the Fed’s meddling.


Robert Craven

Gilts Just Ahead

After our Spring alert that the UK real sector would blow through expectations (the result) and then more recent alerts that there were still more “surprises” yet to come (the result) one would think that observers have about caught on, changed their tired models. Not likely. Thus, the clear risk for key releases just ahead is for something more, not less than is now priced in.

Yet Mr. Carney fears a “false dawn.”  That may be but we are interested in FI price change over the near to intermediate term. We are not investors.  Thus, we have a central bank which will remain generous over the near term, we have a real sector with exhibits “surprising strength” day in and day out, and, we have elevated price reads which are not about to plummet.  This is the recipe for weaker debt prices just ahead.

Finally, Mr. Carney may well hint or actually deliver more QE in an attempt to dampen longer rates. He may do this because despite what one reads in the financial press he is in fact concerned that higher rates may well act as a retardant; and so, he may increase QE. But if he does, it will be by just a tad, not a wallop.  “Just a tad” will backfire and gilts will erode further, not strengthen.  That is the way things work in the real word. 


Robert Craven

Mark Carney - A Quick Study

Mark Carney kept it zipped today.  He is a quick study.  Almost always central bank chiefs get in trouble trying to communicate with a mob.

The financial press has it today that Carney has little fear of much higher rates, suggesting that is why they went even higher. For example, from our good friends at PIMCO, as carried in the Telegraph – “By issuing no statement the [Bank does] not see the back up in yields as being sufficient to risk the recovery, and as such the market has continued to sell-off to new yield highs.” 

Instead, Carney is not one bit comfortable with higher rates and very much does feel they could be a threat; but, he is apparently well acquainted with the first rule of holes – when in one, stop digging.


Robert Craven

US

We have provided clients (and later, blog readers) with value in understanding UK real sector dynamics ahead of most others.

Unfortunately we have not provided the same accuracy for the US.

We predicted more US economic weakness than has materialized. This was tied to our view that risk takers would quail, in the face of 1) a statist administration and 2) an interventionist Fed.  Planners at both organizations could come to no good, and they haven’t. But developments have not been as rough as we expected. We’re off to a slow start to Q3 but we thought earlier that we would be nearly flat.

Next, we don’t have an edge; we can’t sense where most analysts have gone wrong, if at all. We can’t sense value at the moment. And so with interest rates, we can’t offer strategy either within the US or against other sovereign credits.

And then there’s the good ‘ol Fed. Most of us long for the day when the tinkering will end.

Our advice to this organization is as follows: Step one is to set a target, say the PCE deflator at 2%. Forget the dual mandate – it is redundant and a lot of nonsense. Step two is to eliminate interest paid on excess reserves. Step three is to dust off the NY desk and use FF’s as the preferred tool, ongoing. Then sit on your hands.

At one point in our career we were able to strong arm the Fed to listen (with a little help from Congress) and to insist on results. This time around we can only hope.


Robert Craven

The UK - Surprises Yet To Come?

Insight can deliver results but it is courting real trouble to forget that these are ephemeral in nature. All of us have stuck with strategy just a day too long.

In the Spring we isolated a flaw common to most UK economic models; well, not the models actually but the observers, almost all of whom were driving at 90, gazing in the rear view mirror; a perfect case of group-think in economics. Once we had that in hand we in effect had the financial headlines in hand. And that is exactly how things worked out.

Key is to understand just when the analytical horde will catch on.  We updated through August that there were still pleasant surprises to come. And indeed there were, especially in services and in manufacturing, sectors isolated early on.

And now, after having been severely beaten about the head and shoulders for three months, have economists finally sobered up?  That’s generally within the time for a re-set; but our hunch is not this time.

Thus, we can look from more from the dear ‘ol UK economic engine than is priced in. And inflation reads are not coming down any time soon. And we have a stubborn central bank governor who thinks that arguing with the market will provide results.

Look for Gilt prices to ease further. 


Robert Craven