* Borrowing from the future: The Zero Interest Rate Policy (ZIRP) has borrowed past and present sales from the future, underscoring the challenge of future economic growth.
* Unknown consequences of policy: No one knows the consequences of an extended period of ZIRP "punch bowls," often resulting in aberrant behavior and hangovers.
* Making no sense: Indeed, if there were no consequences to ZIRP, interest rates could have been held at zero forever in the past, as well as in the future.
- Kass Diary, "Short in May and Go Away."
The Federal Reserve's extended six-year policy of injecting massive amounts of system liquidity and stabilizing interest rates at near zero has been a powerful force on our capital markets and on stimulating rate-sensitive economic sectors (e.g., housing and autos). But, in maintaining monetary indulgence for such a lengthy period of time, our central bank has now distorted and screwed up our economy and our markets -- perhaps for some time to come.
How We Got Here
At its inception, the Fed, faced with the deepest economic downturn since the Great Depression, justifiably embarked on a plan to reduce interest rates towards zero and to infuse massive amounts of liquidity into the economy through quantitative easing. It did so with the objective of engineering an escape velocity in the economy and, in turn, a self-sustaining recovery.
With our politicians in Washington, D.C., unwilling to find compromise and displaying fiscal inertia, the burden of resuscitating domestic economic growth was squarely on the shoulders of monetary authorities.
At the outset of the emergence from the recession, the Federal Reserve's actions were necessary to stabilize the domestic economy and the world's financial system. However, as time went by, more and more cowbell was the policy recipe delivered from our central banker despite signposts of moderate U.S. economic growth. In doing so, the Fed has adopted a Mae West approach to monetary policy ¿ believing "too much of a good thing can be wonderful."
In time (and from my perch), the benefits of "free money" began to lose their positive marginal impact on energizing economic growth and have begun to sow the seeds of potential problems "down the road."
Throughout the last three years of monetary ease, there were a series of reasons given for continued liquidity injections and zero interest rates. Most recently, the chaos in Greece has been the core of rationale for not raising interest rates.
We now stand more than six years from the collapse of global growth and from the Generational Bottom of the U.S. stock market. At best, monetary policy is arguably no longer providing the fuel for economic growth. At worst, as I will explain, low rates are sowing the seeds for economic and stock market problems.
The Emerging Developing Economic and Market Problems That I See
Like Popeye's Wimpy the Moocher, central bank policy has put a premium on short-term rewards at the expense of longer-term risks.
"I'll gladly pay you Tuesday for a hamburger today." -- J. Wellington Wimpy
Where are the emerging problems (and bad behavior) that has emanated from aggressive central bank policies that are about to boomerang and could weigh on our economy and markets?
- An "Exclusive" Prosperity: Stated simply, those with large balance sheets -- of real estate and equity holdings -- have been outsized beneficiaries of monetary largesse. The social and economic ramifications of an imbalanced recovery will linger for years -- it is no longer a concession of the U.S. The world's lower- and middle-income classes have grown increasingly aspirational, accelerated by a flat, networked and interconnected world that lessens previous and historic opaqueness and expands transparency. It seems to me that the pendulum of an imbalanced recovery might soon begin to move and favor employees over corporations, with company (now elevated) profit margins being imperiled after years of expansion. In other words, Main Street may begin to prosper more than Wall Street, reversing the more than decade-long trend.
- The Disadvantaged Savings Class: Monetary policy has devastated the savings class, which has already been suffering from Screwflation -- a state in which the costs of the necessities of life have increased while wages and salaries have lagged. Further complicating and depressing growth has been the demographic shift towards an aging America. When faced with little yield, a large demographic has cut down personal expenditures and has hoarded cash -- just the opposite intention desired by monetary authorities. With interest rates likely to rise only moderately, this headwind will continue to dampen economic growth prospects.
- Monetary Policy Distorts Markets: With rates anchored at zero, there is limited price discovery in the bond and equity markets. Indeed, it is the unstated (and sometimes stated goal) of central bankers to encourage the investment in long-dated assets. At some point this ends -- badly.
- Pulling Forward Growth at the Expense of Future Activity: Fed policy is designed to pull forward economic activity. The two best examples of borrowing from the future have been in housing activity and automobile sales. Housing has benefited from record-low mortgage rates and autos by plentiful available money (especially of a subprime kind). In doing so, peak housing and peak autos seem to be headwinds to the future economic growth outlook.
- The Seeds of Malinvestment Begin to Sprout: Low rates increase the supply of "stuff" (e.g., the mushrooming growth of shale oil), sustaining those companies (and countries) that should not be sustained and elevating the prices of financial assets against limited progress in the real economy. Lending standards are dropped (e.g., the proliferation of covenant-lite debt offerings), fear is obliterated and complacency proliferates.
- Housing's Prospects are Worsening: In part by encouraging speculative (institutional) investments in residential real estate ("buy to rent"), ever-lower interest rates have served to spur higher home price gains over the last five years. The downside -- despite record-low mortgage rates, there are headwinds to affordability. But the prospective problems may run deeper than affordability and could especially hurt mid-priced housing sales activity going forward. Here I disagree with Jim "El Capitan" Cramer, as, at this point, interest rates have to rise only slightly to hurt housing, as many homeowners are locked into low-rate adjustable mortgages and teasers. They simply can't afford to move and are less likely to move up to larger and more expensive homes as they no longer can replace their low-cost mortgages. Moreover, mortgage credit is not as freely available -- as was the case eight years ago -- as mortgage standards having been raised materially, so yesterday's no doc/lo doc mortgage of $250,000 (with rates near zero) is the equivalent to today's $450,000 mortgage when normalizing the terms. All this, coupled with changing demographic forces (a rental nation), a weak jobs market for young adults and lower household formation, will likely keep the supply of available housing stock at low levels.
- Time Value of Money at Zero Rates: With subpar growth and a zero time value of money, corporations have been in no rush to seek the benefit of making capital investments. If global growth continues to disappoint and rates remain relatively low, the outlook for capital spending will likely continue to be blurred.
- Access to Zero Cost Capital Places a Premium on Financial Engineering: In its extreme, low interest rates give a fictitious and fleeting cover for buybacks. Over history, corporations buy high and sell low. The most recent behavior is no change from this pattern, though it has been on steroids as access to low-cost debt to cover buybacks has been the direct result of intended Fed policy. Indeed, more than $460 billion in repurchases were announced in the first quarter of 2015 and companies sold almost $500 billion in bonds during the past three months to fund some of those buybacks. Over the last six years S&P companies have repurchased $2.75 trillion in stock. Buybacks at ever-higher prices have borrowed from future returns by elevating stock prices above valuations that can be justified by fundamentals and by the state of the real economy.
- Market Expectations Have Grown Unrealistic: Zero interest rates dull volatility, limit price discovery and raise market expectations. As a result, complacency -- few now expect a meaningful correction or bear market -- becomes the mindset, setting up for the possibility of a "Minsky Moment" and disappointment in the event adverse outcomes arise.
No Hot Fun This Summertime
"End of the spring and here she comes back
Hi, hi, hi, hi, there
Them summer days, those summer days...
That's when I had most of my fun back
High, high, high, high there
Them summer days, those summer days..."
-- Sly and the Family Stone, "Hot Fun in the Summertime."
It is said that June is the time of the perfect young summer and the fulfillment of the promise of the earlier months of the year. While there are yet only limited signs to remind us that it's fresh young beauty will ever fade, I am deeply concerned that above byproducts of excessively easy monetary policy over the course of too many years are causing potentially lingering structural issues and headwinds to a balanced trajectory of economic growth in the future. These issues are not likely to be market-friendly or value-enhancing.
Even more concerning is that few are even moderately worried.
My prognosis? There will be no "hot fun in the summertime" of 2015 and the Federal Reserve won't be "taking us higher" anytime soon.
The Bottom Line: Our central bank may have "screwed the pooch" -- a term popularized by Tom Wolfe in "The Right Stuff" and used as a slang expression for doing something very much the wrong way. And our economy and our markets will likely suffer in the years ahead.
This commentary originally appeared on Real Money Pro at 9:18 a.m. ET on June 22. Click here to learn about this dynamic market information service for active traders.
