Is the Fed Targeting Another Bubble?
The U.S. economy added 214,000 jobs last month. This was the 49th consecutive month of payroll gains, the longest streak of positive payrolls in history.
This record-breaking streak may come as a surprise to you, particularly if you’ve been gauging strength in the labor market through the lens of the Federal Reserve. Over the past few years, Ben Bernanke and now Janet Yellen have continued to focus on the negative, emphasizing “labor market weakness” and “slack.” They have done so to justify keeping the Federal Funds Rate at 0% for what will be six years next month (see chart below).
For a long time, the Fed stated that it would be appropriate to keep the Fed Funds Rate in an “exceptionally low range” as “long as the unemployment rate remains above 6 1/2 percent.” Instead of following this policy, they chose to remove this language in March of this year as the unemployment rate approached 6.5%. Today the unemployment rate is down to 5.8% and the Fed is still telling us that rates will be at 0% for a “considerable time” (click here for the October FOMC statement).
Why are they playing these games more than five years into an economic expansion? The answer to this question only make sense when you understand the Fed’s true objective, as I outlined a few months ago in “Slackonomics 101” and “Seven Years Later: What Does the Fed Know?” It is no longer “maximum employment” that they are targeting but instead a maximum “wealth effect.”
In plain English, they seem to be targeting another bubble in stocks. Why would they do so, you ask? They continue to espouse the belief, as Ben Bernanke first outlined in 2010, that such bubbles will lead to a “virtuous circle” of increased consumer spending which will in turn lead to higher incomes and a stronger economic expansion.
What is the problem with such a goal? Surely, we should all want ever higher asset prices, correct? All else equal, perhaps, but all else is never equal. Higher asset prices/inflation coupled with artificially low interest rates without commensurate wage gains and economic growth only leads to a widening “wealth gap” and a massive misallocation of resources and capital. In my opinion, that is where we stand today.
Let’s examine the evidence supporting my assertion that the Fed must be targeting another bubble…
This has been the slowest wage growth expansion in history with the gap between the richest and poorest Americans widening substantially (according to the Fed themselves).
This has also been the slowest economic growth expansion in history, with year-over-year real GDP averaging 1.8%.
Meanwhile, U.S. stock prices have more than tripled since March 2009…
Leaving valuations above the 94th percentile on a historical basis (1881-Present).
Targeting Another Bubble
Given such evidence, to believe that the Fed is targeting anything but another bubble in stock prices at this point would be an enormous leap of faith. How could one rationally conclude otherwise? Six years of easy money has unquestionably inflated asset prices but failed to have a proportionate effect on the real economy. If maintaining 0% interest rates was really about wage and economic growth, wouldn’t we have seen it by now after six years?
Far from admitting this and starting to normalize interest rates (which if they followed prior cycles would have been done back in 2010), the Fed seems to be doubling down here on their “wealth effect” theory. During the recent 9% S&P correction, expectations for the first Fed rate hike were pushed all the way back to September 2015 after a number of dovish statements by Fed members were released. This was to be expected. After all, if your main objective is to create another bubble you cannot allow even shallow 9% corrections without intervening.
The stock market quickly raced back to new highs on this news which is where it stands today. If the futures market is correct, it will be almost seven years of 0% rates before the Fed finally raises rates. If there is a larger correction between now and then or any signs of economic weakness, you can bet this timetable will be pushed back once again.
What will the effect of another year of 0% rates be on markets? The Fed and most market participants are betting all of their chips on another bubble that will drive multiples higher, borrowing from the future to satisfy the whims of today. Make no mistake about it, this is precisely what they are doing as there is no free lunch in markets. If you pull forward demand (returns) to today, demand (drop) in the future will drop. This is no different from cash-for-clunkers.
The more important question in my view is whether this is really the policy we want to be following five years into an expansion. Have we really learned nothing from the booms and busts of the internet and housing bubbles? Is creating another financial asset bubble the most effective long-term policy to generate economic growth and increase prosperity for all? It is clear by now that the Fed believes so. What do you think?
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
CHARLIE BILELLO, CMT
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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