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Current Views

Trauma of the Tape

Grim, choppy, and sloppy, it is certainly a time of transition. In the U.S., we are anticipating a new government, with all the uncertainties that brings. China is amidst an economic conversion. Technology and shifting global politics have turned the energy market on its ear. At this point the Federal Reserve wants to move on from a now long-gone recession. A lot is happening and because of that, we see tremendous volatility and a paucity of liquidity—which typically makes for fragile markets.

The U.S. consumer is not indicating recession, at least as measured by employment and wage measures. Payroll growth may be slowing down, but seasonality is probably obscuring that, and certainly wages are growing. We see the decline in energy prices as a tailwind for consumers too.

In contrast, U.S. industry is much less robust, and arguably very cautious. In addition, there seems to be renewed concern about banks. Zero-bound interest rates are unhelpful for banks and prior expectations that rates could move higher now seem overly optimistic. Prospects of slower economic growth, a flatter yield curve, and write-downs from energy loans have further dimmed expectations.

Even worse than being a banker in the U.S. could perhaps be serving as a banker in Europe, where rates are already negative and there was perhaps less reining in of risk over the last couple years. If banks are a leveraged exposure to economic growth, then the market’s expectation for growth is not looking too good right now. Emerging and developing markets are already weakening, and in China capital is fleeing, heading offshore. Peripheral markets have been on a rollercoaster. Investors have looked at all this and smacked down global equities, reversed the dollar’s gains, and discounted the prospect of further Fed tightening this year. Are the markets right? Or, what would it take for the market to regain its confidence?

Before he became a member of the Fed and a key contributor to the Bretton Woods agreement, Marriner Eccles owned a number of banks in Utah during the Depression-era. When there were bank runs, which were common, he would have the staff wheel in large carts of cash through the front door and pile it up next to the tellers. The message was simple: there’s plenty of money and depositors were not to fear. Later, Treasury Secretary Hank Paulson would echo a similar message with the concept of the Treasury’s “bazooka”. Again implying, “there is nothing to fear here, we can fix this”.

Investors today wish for the same. Yet looking at the Fed, there is perhaps a growing realization that zero-bound, or even negative, interest rates are not quite the solution they may appear to be, and frankly might stoke disinflationary concerns, not alleviate them. Other potential policy approaches today appear absent, lacking, inept, or impotent. Former President of the Federal Reserve Bank of St. Louis William Poole opined this week that negative interest rates, as now practiced in Europe and Japan and hinted at as a solution in the U.S., are simply ineffective and distract from the structural reforms that would be more effective. Poole suggests that regulation is choking business investment and that tax laws need reform, though clearly this is simply the top of his list. What is obvious to him is that animal spirits that are not stimulated to borrow and invest at 1% are not likely to emerge at borrowing costs even lower. There simply is no investment scheme that is made viable or not viable, with all its inherent variables, by a shift in the hurdle rate by a percent or so. Of course no entrepreneur thinks that way; to Poole’s point, tax and regulatory policies are far greater risk variables. But leadership on these key points is missing. [1]

The question remains, where do we go from here? Fed Chair Janet Yellen spoke last week, and clearly implied that the Fed is market dependent. It appears the Fed views markets as indicating that the economy is at risk. Tightening tantrums in financial markets do concern her. While the stronger dollar did much of the tightening work they expected to do, the stark widening of credit spreads and the prospect of write-offs resulting from energy investments simply augment the pain of lower stock prices. It’s a rocky time for investors.

 


[1] Wall Street Journal



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