THE ECONOMY:
FOMC minutes shows more unity in rate hiking.
The market seemed to take the FOMC minutes in stride, moving higher into the close the last hour after they were released. In doing so investors appeared to view the minutes as nothing new. Things have changed, however, and they may come home to roost later.
First, the vote on the rate hike was unanimous. Unlike the prior meeting there was no contingency questioning in the need for further rate hikes and indeed asking for no additional rate hike. With McTeer no longer heading up the Dallas Fed, it appears that more of the free market spirit of the Fed has left. As there was not much free market spirit in the first place, this is a real concern as to the Fed's viewpoints once Greenspan retires. That is why it is key to have a free market chairman such as Glenn Hubbard appointed.
In any event, the vote for the hike was unanimous, a change from prior meetings. Moreover, there was also unanimity with the idea that more rate hikes are needed in the future to control inflation. The statement expressly stated the current level for short-term treasury rates is too low to be consistent with price stability in the future.
Thus the second point: there was no indication whatsoever that the Fed is going to stop hiking rates anytime soon. As noted, the statement concluded that current rates are too low, thus more hikes are needed. Further, the Fed continued its 'measured pace' stance, stating that phrase characterized its stance moving forward. The Fed noted an uptick in inflationary pressures and that prices were being passed from producers to consumers. It even delved into the housing market, noting that overall things were fine but that some local markets were 'hot.' What the hell the Fed has to do with the housing market is anyone's guess, but the Fed knows no boundaries any more. We would not be surprised if the next round of minutes said something about shorting Google.
All of this adds up to a Fed that is dead set on raising interest rates on into the future. These minutes were from a meeting 3 weeks ago. Since then the economic outlook has improved somewhat with the soft spot receding pretty quickly. There are still issues with the regional manufacturing reports, but that is not enough to forestall or change the Fed's mind. On balance the data of late suggests a stronger economy than three weeks back; all the more reason for the Fed to continue raising rates.
The issue confronting the market is whether the Fed hikes two more times to 3.5% or on up to 4.5% as some suggest. We would love to think two and out, but we also know the Fed's history of hiking one time too many, some times two or three times too many. If the Fed follows its history, it will hike to 4% or better, and that will invert the yield curve. That will usher in a recession just as the Fed has done in 8 of the last 10 rate hiking campaigns. Each time we hope that the Fed has learned how to gauge when enough is enough, but it behaves just like an emotional market: it swings too far both ways, whether in cutting rates or in raising rates.
That eventually would mean more trouble for the market once it starts to figure out the Fed is not nearly through and will tighten into a flat or inverted curve. The mind-blowing aspect of this is that the economy is nowhere near at potential. We still have millions out of work from the last recession. We still have retirement accounts in ruin. We still have not come close to regaining the technological edge we lost when our tech sector crashed. We may not ever get that back, but should we not at least try? Why undercut the power of the tax cuts at jumpstarting major investment in the US and thus growing our economic foundation?
Why not? Because the Fed is too busy worrying about everything in the economy and indeed everything in the world while trying to apply a theory (the Phillips Curve) that only describes a short period in the history of world economics. It looks at the economy recovering in housing, manufacturing, investment, and yes it sees GOOG and SHLD at high prices, and it is drawing the wrong conclusions that things are too hot just as it did back in 1999 and 2000. Yes rates were too low and they probably still are, but as we have often said, the Fed should just go ahead and move rates up to 3.5% or 3.75% at once, keep the money supply healthy, and then say it is going to wait and see how things pan out. That would help the market deal with the future as opposed to the indefinite 'measured pace' water torture that the market is set to endure for at least another two months and possible another seven to eight months.
Existing home sales surge 4.5% and to a new record.
One person's bubble is another person's healthy market. The 7.2M annualized units in April topped expectations. Prices rose over $200K on average, up 7% from March. That jump has the bubble-ites out in force. On the other hand, mortgage rates fell unexpectedly as the 10 year treasury continues to rally, and that fueled much of the activity. One thing is certain: the housing market performs well when rates are low. The Fed is trying to push up long term rates by bumping the short end, but thus far all it has done is manage to flatten the yield curve further.
As noted above, the Fed only works on the short end, and from there it presumes the long end will rise. Greenspan's conundrum is the long end's refusal to move higher. Indeed, the 10 year treasury bumped 4.00% again Tuesday before closing at 4.03%. Despite the Fed's efforts the long end is reacting to market forces, not the Fed. Rates are thus low and the housing market thus still strong.
What worries us deeply now is the Fed's foray into housing prices. They popped up in Greenspan's recent speech. They appeared in the FOMC minutes. The Fed is once again looking for trouble, trying to pick a fight where there is none. It is trying to be our economic parent when we don't need one. Greenspan talks of free markets, but then proceeds in a 'I know what is best for the economy' fashion, ignoring low long rates (calling them an aberration) and gold's complete failure to price in any inflation. Sure Greenspan is still saying it is not a bubble, but when he starts talking about something he fully intends to make it an issue. You can already see the transition in his rhetoric from him blowing it off in questions by Congress just a month ago to now saying there are bubbles cropping up. It is a pattern seen in 1996 to 2000, and it is starting again. That is why we are extremely concerned about how far the Fed is going in this rate hiking campaign. |
