An Ungrateful Fed With a Possible 3rd Mandate?

by Victor Sperandeo, with the Curmudgeon



As expected, the Fed did not raise rates at its FOMC meeting last week.  Only one Fed Governor – Jeffrey Lacker from the Fed's Richmond bank – dissented from that decision. Victor's comments and opinions on the market reaction to “no Fed rate hike” are described.  With tongue in cheek, an alternative course of action for the Fed (?) is proposed.   The CURMUDGEON provides a history lesson about the famous “Fed punchbowl” speech to remind readers of the dangers of Fed inaction on rates.  Victor then analyzes the Fed and the U.S. economy and opines on the major trend of the U.S. stock market.  He concludes with a possible third mandate for the Fed, based on Chairwoman Yellen's remarks during Thursday's press conference.


As usual, all opinions expressed herein are those of Victor Sperandeo.

Market Reaction to Fed's No Rate Rise Decision:

Stock markets in Europe and the U.S. were certainly not cheering the Fed's “stand pat on rates” decision Thursday.  The U.S. stock market briefly rallied on Thursday with the DJI up almost 200 points after the Fed's announcement, but the market then sold off on the news, which had already been largely discounted (see Victor's comments below).  The decline steepened on Friday with some European bourses down ~3% while U.S. stock market indexes were down ~1.7%. 


Meanwhile, Treasury notes and bonds rallied, especially the short end of the yield curve, on the presumption of weaker than expected economic growth (John Williams of is calling for a recession this year).

Victor's Comments and Opinion:  

The friends of the Fed are like the fans of Donald they say, the Fed can do no wrong? After 6.75 years =81 months =2,484 days, they have given their believers free money and propped the market up with various money printing schemes, especially multiple rounds of QE.  Forget about removing the punchbowl1 … a party that never stops is always a hit.  Or is it?


Note 1.   Fed Chair William McChesney Martin in a speech to the New York Group of the Investment Bankers Association of America on October 19, 1955 (bold font emphasis added): 

"If we fail to apply the brakes sufficiently and in time, of course, we shall go over the cliff.  If businessmen, bankers, your contemporaries in the business and financial world, stay on the sidelines, concerned only with making profits, letting the Government bear all of the responsibility and the burden of guidance of the economy, we shall surely fail...In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects.  If it did not it would be ineffective and futile. Those who have the task of making such policy don't expect you to applaud. The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up."


After not raising rates, the Fed could have bought stocks via the PPT or other surrogates (as they usually do via stock index futures and/or ETFs) to make themselves look good while keeping their believers happy. Instead, they allowed stocks to decline by almost 2% on Friday, which let their fans down. 


Is the Fed ungrateful to their large following, which wants to keep the free money party going?


The Fed and the U.S. Economy:


The Fed has overseen the worst "economic recovery," not just post WW II, but in the entire history of the U.S. - at least as far back as data exists.


Take the 1929-1933 depression and recovery2 as an example. The National Bureau of Economic Research (NBER) shows the trough of the depression as March 1933.  Real GDP increased in 1934 +10.8%, in 1935 by + 8.9%, in 1936 by +12.9%, in 1937 by +5.1% for a compounded annual growth rate of 9.39%. However, GDP was down -3.3% in 1938.  In 1939, GDP growth continued at +8.0, and also in 1940 at +8.8%. 


Note 2.  Source for the above data is from:  

Despite the miniscule U.S. economic growth of the 6+ year “economic recovery,” the Fed gets a pass as “savior of the world” for rescuing the U.S. and global economy from the 2008 financial crisis (which ironically accelerated after the Fed & U.S. Treasury let Lehman Brothers fail in September).  Fed defenders say: "it was worst financial crisis since the great depression and the Fed saved us from another depression."


One must conclude that the 2008 financial crisis is the reason for the slow growth of 2.2% from the end of 2009 to June 2015. [Yearly annual real GDP growth has been:  2010 +2.5, 2011 +1.6%, 2012 +2.3%, 2013 +2.2%, 2014 +2.4% 2015 2.2%.]


Those who have researched history know that the worse the recession, the greater the subsequent economic expansion. “In general, recessions associated with financial crises are generally followed by rapid recoveries,” according to an academic paper with lots of interesting tables and graphs. 

That's except for the current “economic recovery,” which has been masterminded by the Fed's “free money party,” the ineffective fiscal policies of the Obama administration, and a do nothing Congress with approval ratings near an all-time low. 


As a believer in the Austrian School of Economics (which is anti- Keynesian), my view has been that the U.S. economy would be weak since the recovery started in June, 2009.  With President Obama's political agenda, the U.S. has experienced economic stagnation.  The Fed has played offense (ZIRP and QE) and now defense (end of QE and forthcoming rate rise), yet it's becoming completely impotent.     


An Incongruous Comment from a Fed Regional Bank President:

The most laughable, and truly disconsolate comment coming from an FOMC member recently was from Narayana Kocherlakota (President and CEO of the Federal Reserve Bank of Minneapolis).  In an August 19th WSJ editorial:  Raising Rates Now Would Be a Mistake.  He gives all the well-known reasons, but ends with this gem:

"I am confident that the time will come - when economic conditions will be appropriate for the FOMC to raise the Fed-funds rate from its current low levels."


Really??? A TIME WILL COME WHEN? This is after 6.75 years of the greatest monetary and fiscal stimulus in the history of the world, which includes: rounds of QE that increased the Fed's balance sheet 5 times, ZIRP which crippled savers and severely pinched retired folks living off interest income, and U.S. government debt that doubled.


Mr. Kocherlakota evidently believes the economy will grow or be strong enough at some point in time for the Fed to raise the Fed Funds rate 25 bps.  In other words, praying that what has NOT worked for the economy, will magically work someday? 


It's people like Mr. Kocherlakota who are responsible for the U.S. banking system, and are COMMISSIONED under the Federal Reserve Act of 1913 to run the nation's money supply, credit system, and the current $4.5 trillion long portfolio of U.S. and mortgage backed debt (i.e. the Fed's Balance Sheet).   Kocherlakota’s mentality and central planning hubris is emblematic of what's wrong at the Fed.  A more detailed critique of his flawed thinking is here.  


Current Position of the U.S. Stock Market:

China not getting IMF reserve currency status (widely reported on August 19th) caused stock markets around the world to decline after China's market plunged.   The contagion spread very rapidly.   I believe that event caused the U.S. stock market to enter the first leg of a bear market.  However, if the July stock market highs3 are taken out then that assumption is incorrect.


Note 3.  The NASDAQ composite closed at an all-time high of 5218.85 on July 20, 2015.  It closed Friday at 4,827.23.  The S&P 500 closed at 2,128.28 on July 20th with an intra-day high of 2,132.82 that same day.


Caveat: If the U.S. government wasn't so incredibly involved in every aspect of central planning the economy, I would be surer of my bear market analysis.  If the Fed can dare loan out $16 trillion during 2008, and hide that from the public, then why can't it now buy $16 Trillion in stocks?


Counter Trend Rally May Have Ended on Thursday, Sept 17th:

The U.S. stock market rally due to “no increase in rates” came BEFORE the Fed's announcement, rather than AFTER as I suggested in a previous Curmudgeon column.

That's because it was so very well known (i.e. IMF and World Bank asked Fed not to raise rates as did others) and therefore completely discounted by the stock market.  The U.S. stock market rally from September 10th to 17th was a classic “buy on the rumor-- sell on the news” type of effect, with a strong reversal to the downside after Thursday's Fed announcement.

One possible reason for Friday's follow through decline was the view that the U.S. economy was too weak for the Fed to raise rates (although that too was well known in advance, but apparently NOT discounted by the short end of the Treasury yield curve which rallied sharply).  A weaker economy translates into lower corporate profits which is not good for stocks.

Perhaps, the quadruple witching hour, with September stock options, stock index options, index futures/options and stock futures (created in 2001) all expiring on Friday, contributed or even caused the decline?   

Conclusion: a Third Mandate for the Fed?

Note that both of the Fed's chartered mandates- price stability and full employment - have been accomplished in statistical terms.  Let's examine if the Fed is now looking for a third mandate?   


During Thursday's press conference, Fed Chairwoman Yellen said: “heightened uncertainties abroad, including the Chinese economy’s weakness,” had helped persuade the U.S. central bank to not raise rates at its September 16th-17th FOMC meeting.  More specifically, Yellen said (bold font emphasis added by the CURMUDGEON):


The outlook abroad appears to have become more uncertain of late, and heightened concerns about growth in China and other emerging market economies have led to notable volatility in financial markets.


In answer to a question from Peter Barnes of Fox Business, Yellen replied: 


…we reviewed developments in all important areas of the world but we're focused particularly on China and emerging markets. Now, we've long expected, as most analysts have, to see some slowing in Chinese growth over time as they re-balance their economy. And they have planned that I think there are no surprises there. The question is whether or not there might be a risk of a more abrupt slowdown (in China) than most analysts expect. And I think developments that we saw in financial markets in August, in part reflected concerns that there was downside risk to Chinese economic performance and perhaps concerns about the deafness with which policymakers were addressing those concerns.”


Is that statement equivalent to an implicit third mandate for the Fed?  Is China's economy, financial market stability, or politics the reason(s) for the Fed's decision not to lift short term interest rates?


Let's turn to the words of JP Morgan, the greatest banker in U.S. history, who once said: 


"A man (or a woman) has two reasons for doing anything--a good reason, and the real reason."


Upcoming Speaking Appearance:


I will be speaking at the 7th Annual Mises Celebration at 7:30pm on Sept 26th in San Jose, CA.  Jeffrey Tucker's keynote speech at 8pm will be on "Why Mises Still Matters in the Digital Age."  Invitations to attend this reasonably priced event are extended to readers via the above hyperlink.  The Curmudgeon will also attend, but incognito as his identity must always remain a secret.


Good luck and till next time…


The Curmudgeon


Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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