The title of “Fed Whisperer” John Hilsenrath’s postmortem article on this week’s FOMC meeting is kind of amusing.
When I think about the word chapter, I think of just one part of a larger narrative. And considering the length in time of the Quantitative Easing we just saw, it seemed more like the entire a book. But he has a point. Until the Fed actually starts raising interest rates significantly (perhaps beginning next spring or summer) easy money remains.
Much of the debate over the last few weeks has been on the actual effectiveness of the Fed’s monetary policy on the real economy, not just the price of risk assets. Without being too redundant, let’s summarize some of the simple economic effects per the WSJ’s Steven Russolillo (emphasis mine):
As WSJ’s Jon Hilsenrath reports, the worst fears about the Fed’s actions – rising inflation and a devalued currency – haven’t come to pass. Inflation, as measured by the Commerce Department’s personal-consumption expenditure price index, has been unchanged at 1.5% since September 2012, when the Fed started QE3. Meantime, the dollar, as measured by the Fed’s broad dollar index, is up 6.7% in value compared to the world’s other currencies.
But its benefits are also questionable. While the unemployment rate has fallen sharply – from 8.1% before the latest program was launched to 5.9% in September – the drop is mostly due to people abandoning the work force. As WSJ reports, some 2.2 million jobs were added in the 12 months before the Fed launched QE3 in Sept. 2012. In the past 12 months, that figure has risen to just 2.6 million, not enough to suggest the Fed’s efforts created a material impact on the labor market.
Where the Fed has succeeded is driving investors into risky assets, such as stocks. The S&P 500 has risen 35% since the Fed launched QE3 and has hit a number of record highs along the way.
Despite new found optimism by the FOMC about the U.S. economy, it seems that it comes at a time when there is little to be optimistic about globally. This morning’s Q3 GDP print of up 3.5% certainly supports the Fed’s optimism, but given the commentary of late regarding forward earnings guidance as well as the expected Ebola related disruptions in the start of the fourth quarter, it makes sense to see a little give back when we get the Q4 reading in late January.
So the Fed is passing the baton to the ECB, and will now be “data dependent” without a formal QE plan in place. My translation is that we should be ready for higher levels of volatility as market participants handicap if and when the Fed will move towards tightening, which could play out simultaneously to easing announcements out of the ECB. This could get a confusing.
My assumption is that dollar strength will be a theme in this scenario and could serve as a fairly massive headwind for U.S. multinationals. Those multinationals will depend on overseas demand for much of their future growth.
So when we think about the Fed closing a “chapter on easy money”, it’s possible it’s just a brief pause in QE, but not likely. The risk to the market now is if Europe and China run into more trouble and the U.S. can’t de-couple from a global economic malaise, because the Fed is now alot less likely to swoop in to the rescue. We may see it in words out of the Fed, like Bullard a couple weeks back but alot of the actual central bank onus now rests on others besides Yellen.
Despite the correction earlier in the month, the mood among investors remains profoundly bullish as it relates to U.S. equities, with the SPX now 2% from the all time highs. Prior to the sell off, I did not think the risk reward was favorable with the SPX at 2000 to commit new capital to U.S. equities, and I stand by that position now. That being said, I recognize the seasonal factors that could drive us to new highs, coupled with the potential for positive sentiment post the mid-term elections. But as I noted in yesterday’s MorningWord, the waning momentum and lack of breadth in the Nasdaq with prior leaders like most large cap internet stocks falling by the wayside suggests that we could be closer to the end of a chapter in U.S. equities as opposed to the beginning on a new one.