Mark Hulbert has a piece this morning at MarketWatch in which he de-correlates the first Fed interest rate hike from any supposedly corresponding stock market movements. I agree with some but not all of what he writes. Let’s take it a chunk at a time.
Are you obsessed with whether the Federal Reserve will begin to raise official interest rates in July, September or sometime next year?
No. I’ve wanted them to do it for years now. So I’m obsessed with why the Fed refused to raise rates, despite a strong economy and inflation signals that were not nearly so tilted toward the dis-inflationary end of the spectrum as they are now. I am obsessed with wanting to know why the mainstream media and financial establishment even take their oh so heavily anticipated policy decisions each month seriously. I am obsessed with the all too obvious underlying message that this is all about a stock market ‘wealth effect’ that eventually trickles a little stream down Main Street, with Grandma and other prudent savers thrown in the gutter.
A review of historical data fails to find significant statistical support for believing that higher rates are in themselves bad for the stock market. And even if they were, the difference of a few months in the timing of increases makes little difference when determining if equities are expensive or cheap.
I concede that both of those beliefs are far from conventional wisdom on Wall Street. But the job of the contrarian is to challenge norms.
Agree. But I am not sure why Mark is using the 10-yr yield in his article. With the Fed at work on all parts of the curve, the whole thing is corrupted and not subject to extrapolation of historical data anyway. But insofar as it would be, why not use the Fed Funds rate or the 3 Month T Bill? This chart from NFTRH has clearly shown that rate hikes did not matter to the stock market for extended periods on the last 2 cycles… until of course, they suddenly mattered… big time.
Ten-year nominal rates continue to drift back towards the 2012 lows; the 10y Treasury yields only about 1.75% now. But 2015 is so very different than 2012 in terms of the cause of those low rates.
Nominal bonds are like the packaged sandwich you pick up at a gas station: no special orders. You get the meats in the proportions they were put on the sandwich; in the case of nominal bonds you get real yields plus inflation expectations and the nominal yield moves the same amount whether the cause is a change in real yields or a change in inflation expectations. If you buy nominal bonds because you think the economy is growing weak, and you’re right but at the same time inflation expectations rise, then you’re out of luck. You get what’s in the package.
If you look beyond the packaging, to what is making up that 10-year yield sandwich, then the difference between 2015 and 2012 is stark. When 10-year nominal yields were at 1.50% back in 2012, 10-year real yields were at -0.90% and 10-year inflation expectations were around 2.40%. The bond market was pricing in egregiously weak real growth for the next decade, coupled with fairly reasonable inflation expectations. TIPS were clearly expensive at the time, although I argued that they were less expensive than nominal bonds. (In fact, I may have said that they were expensive to everything except nominal bonds).
Today, on the other hand, nominal yields are low for a different reason. TIPS yields, while low, are positive (10-year real yields are 0.13% as I write this) but inflation expectations are very low. So, in contrast to the circumstance in 2012, we see TIPS as very cheap, rather than rich.
One way to look at this difference in circumstance is to study how the proportions of meats in the sandwich have changed over time. The chart below (source: Enduring Investments) shows the percentage of the nominal yield that is made up of real yields. The percentage which is made up of inflation expectations is approximately 100% minus this number, so one chart suffices. Back in “normal times,” real yields tended to make up 40-50% of nominal yields.
Personally, I found the year revolting as an honest market participant, but thankfully made like a caveman and simply used my tools to help me avoid the pitfalls of my emotions and logical mind. I try very hard to tune down the Tin Foil Hat stuff, but I continue to be in awe of Policy Central and the depths of what looks to me like depravity that they will stoop to in order to keep up appearances. Reference Operation Twist and its “inflation sanitized” selling of short-term notes and buying of long-term bonds.
Who would’ve thought managing an economy and a financial system could be so easy, so controlled and well, so sanitary? Of course, that was way back in 2011, when the macro began to quake in anticipation of change. An anti-market (AKA gold) was brought under control but good and though the masses would hold tightly to their fear (so deeply ingrained from 2008) for another year or more, 2013 and 2014 saw increasing momentum toward a complete recovery of hurt feelings from the 2008 crisis time frame.
The Fed is heading for another catastrophe–Stephen Roach @ MarketWatch[biiwii comment: will said catastrophe arrive any time soon with everyone – incl. biiwii/nftrh – micro managing its progress? valid question]
No Santa Claus for Biotechs This Year–Price Action Lab[biiwii comment: BTK is one of NFTRH’s momentum leaders and an indicator on the overall market pertaining to the question of whether the market is preparing an upside blow off, correction or bull’s end… BTK is battered but remains unbroken as of this writing, per a now-public NFTRH update from yesterday]
[Semiconductor] Manufacturing Constraint Fears Grow–Semiconductor Engineering[biiwii comment: NFTRH has tightened up its watch on the Semi equipment industry because this is where the strong economy began and it will be where the first inkling’s of its end will be seen]
Fed’s policy trajectory is tied to global recovery from SoberLook. [biiwii comment: Agreed, in that there is little pressure implied on the Fed from global and ‘strong dollar’ perspectives. The pressure would come (IMO) from any desire to keep up appearances considering that ZIRP appears to the average person to be stranger and stranger given the ramping economy. Anyway, SL as usual has the grounded and sober details].
This CNBC article starts off with the usual pablum about interest rates and how the Fed may decide to hold off beyond next spring given the lack of inflation expectations and effects in the economy. It’s brain melting mainstream media Pap 101.
Really? Ya think? As if its ears were burning here comes my favorite US market related macro chart…
There is no decision for the Fed to make. They must keep interest rates at ZERO or what has been constructed out of ZIRP ingredients (with periodic injections of QE) is going to come down with a withdrawal of those ingredients.
The article goes on to get a little more intelligent as it considers the view of a rabble rouser named Dick Bove. What he discusses below is in line with the NFTRH view that there are so many pieces in motion now, the world over, that it is impossible to work up traditional market analysis and apply it to traditional forecasting methods. It is in line with what I have been saying since they began phasing out QE3 (as expected), which is that they will not or cannot dare repeal ZIRP, which has been the real policy mechanism at work for 6 years now. Read…
Deformations On The Dealer Lots: How The Fed’s ZIRP Is Fueling The Next Subprime Bust
On any given day, Janet Yellen is busy squinting at 19 essentially meaningless labor market graphs on her “dashboard”, apparently looking for evidence that ZIRP is working. Well, after 71 months of zero money market rates—-an unprecedented financial absurdity—-there are plenty of footprints dotting the financial landscape.
But they have nothing to do with sustainable jobs. Instead, ZIRP has fueled myriad financial bubbles and speculations owing to the desperate scramble for “yield” that it has elicited among traders and money managers. Indeed, the financial system is literally booby-trapped with accidents waiting to happen owing to the vast mispricings and bloated valuations that have been generated by the Fed’s free money.
Nowhere is this more evident than in the subprime auto loan sector. That’s where Wall Street speculators have organized fly-by-night lenders who make predatory 20% interest rate loans at 115% of the vehicle’s value to consumers who are essentially one paycheck away from default.