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Hawkish Hike May Backfire on Fed – Ep. 258

Summary

Quantitative Tightening Ahead:

The Federal Reserve came out with a surprisingly hawkish rate hike today, announcing plans to  shrink the balance sheet by $50 billion per month.  This would mean an annualized rate of $600 billion per year in new treasuries to hit the market. This does not take into consideration existing budget deficits or future spending. The Fed’s policy reversal, in the face of no corroborating positive economic data, is still “data dependent”.

No Good News:

Meanwhile, the “recovery” was the weakest recovery in history, with a doubling of the national debt, we have bubbles in the stock market, the real estate market, in the bond market market, the automobile market, student loans.  We have eviscerated our labor market with people having multiple part time jobs and this is the Fed’s definition of success!

Perfect Storm

Now you’ve got a perfect storm for stocks: falling earnings, weak economic data, rising interest rates and the Fed flooding the market with treasuries.  Now maybe the stock market will take a second look at this hawkish hike and the implications of the Fed’s rate hike plans in conjunction with quantitative tightening later this year in the face of a weakening economy.

  • A lot of people, myself included, were looking for a dovish rate hike today coming from the Federal Reserve
  • What I mean by a dovish hike was that the Fed would hike rates, because after all, everybody expected them to hike rates and they don’t want to disappoint market expectations
  • They don’t want to raise any cautionary flags that they know something that they have not been forthright about
  • I was expecting the Fed to acknowledge somewhat the weakening economic data to the point that itis now waiting for some confirmation that Q1 weakness was transitory
  • And since such confirmation has not been forthcoming they may have acknowledged it
  • But that’s not what happened
  • We actually got a hawkish hike
  • Not only did the Fed raise rates but they did nothing to dampen expectations for future hikes
  • In fact, Janet Yellen in her prepared remarks and in the press conference that followed was very upbeat, very optimistic on the economy
  • Not worried about anything, no longer talking about the need for confirmation that prior weakness was transitory
  • She seems to just believe that it was
  • She thinks it is clear skies as far as the eye can see
  • Looking for economic growth of just under 2% a year
  • Not as optimistic as Donald Trump, looking for 3 or 4% growth
  • But she doesn’t see a recession coming
  • She sees the economy continuing to perform at this 1.8 – 1.9% annual GDP
  • She continues to see improvement in the labor market
  • She’s not worried about the decline in labor force participation
  • She says it’s holding steady and again she dismisses the low participation rate due to the ageing of the population, so she’s very optimistic
  • And something else she said that I think surprised the markets and made this more of a hawkish hike
  • Was she actually talked about starting the shrinking of the balance sheet this year
  • most people thought that maybe it would start next year, at least the rhetoric would say it would start next year
  • Whether it actually starts or not remains to be seen
  • But now Janet Yellen seems to suggest the Fed is ready to get started very soon with its normalization process
  • In fact, she didn’t use these words
  • But it’s really a reverse quantitative easing or quantitative tightening
  • What Yellen basically said is that they are going to start off by tapering down their balance sheet by about $10 billion a month
  • She actually specified, I think, $6 billion in treasuries and $4 billion in mortgage backed securities
  • And they are going to gradually increase it each month until they are shrinking the balance sheet by $50 billion per month!
  • $50 billion per month!
  • That is an annualized rate of $600 billion per year in new treasuries that are going to hit the market
  • And that will need new private buyers
  • Now remember, this $600 billion in quantitative tightening would be in addition to the budget deficits we are already running
  • Which are going to be much higher than $600 billion
  • And of course, if you look at the Administration’s forecast of much higher growth
  • If the Fed is correct and growth is just under 2%
  • Then obviously the budget deficits will be a lot larger than the Trump Administration is anticipating
  • And that’s even before we get any tax cuts or any increased spending
  • So the idea that the treasury markets can absorb, not only the enormity of the budget deficit but the additional $600 billion a year in quantitative tightening…
  • Now the bond market did not even sell off
  • Bonds were up on the day; treasury yields fell
  • Bond prices rose, not yields backed up slightly after the Fed’s rate hike
  • Because prior to the Fed’s rate hike we had a huge rally in the bond market
  • That rally barely reversed even after the Fed announced its plans for quantitative tightening