Go on...take it. Regular readers of my (RM) columns will know I like to make references to 1980s pop culture. I couldn't help but think of Eddie Murphy's brilliant "White Like Me" SNL sketch when listening to Fed Chair Jerome Powell's press conference yesterday. As Eddie's alter ego is handed wads of cash by a willing banker, so is the U.S. financial system by the Fed.
The market's focus on the Fed's quantitative tightening program (QT,) which began in October 2017, always seemed overblown to me. This Fed is dovish. Full stop. As soon as the financial markets wheezed in the fourth quarter, Powell and his colleagues at the Fed started to send messages that QT would be ending soon. They drew a line under that program by announcing yesterday that QT would effectively end in September,
A better measure of the Fed's willingness (I don't think anyone has ever doubted that institution's ability) to open up the monetary spigots is shown in the growth of M2, the most commonly used measure of money supply. After a recent peak of 7.8% year-on-year growth in October 2016, M2 growth had declined steadily to a level near 3.5% by October 2018. That's when the markets started to react, and, voila, M2 growth has re-accelerated in recent weeks, with the most recent reading showing a 4.5% year-on-year growth rate.
So, the Fed is willing to work in tandem with the U.S. Treasury (the ultimate guardian of M2) to produce a steady influx of cash to U.S. banks any time the stock market falters. Or so it would seem. What those banks do with the money is up for debate, but the best measure of that is C&I lending, i,e. loans to commercial and industrial customers. As reported by the Fed, C&I lending rose a sizzling 10.1% in the fourth quarter, a strong increase from the lull seen in 2017 and 2018, including a negative reading for Q1 2017.
What's the downside to this? Classic macroeconomic theory tells us that increasing the supply of money at a rate greater than the natural increase in demand will devalue assets, both financial and nonfinancial. Inflation is a real fear now. With the recent extraordinary decline in interest rates (I never thought I'd see the 5-year U.S. Treasury note yielding 2.32% again in this economic cycle) the dollar will weaken, as well. That leads to higher prices for oil (we're holding $60/bbl today for the first time in six months,) and also imported goods, which make up the vast majority of U.S. consumer purchases.
So, the U.S. consumer is going to be pinched by the Fed's shift to a policy of even-easier money. If banks respond by trying to increase consumer credit, the partially-inverted yield curve will result in much lower margins for the financial sector as a whole. If banks respond to lower margins by increasing loan volumes with lower credit standards - both for consumers and corporates - those banks could be creating future defaults after a three-year period of remarkably few bankruptcies in the U.S.
None of that matters to the U.S. stock market on a post-Fed day like today. I would warn you, however, that profit warnings from global bellwether companies like FedEx (FDX) and BMW (BMWYY) , and blow-ups like today's 29% decline in Biogen (BIIB) shares will continue to happen with increasing frequency. I am not blaming the Fed for Biogen's plummet--aducanumab has been a troubled drug for years and, by my figuring, was never the silver bullet Alzheimer's treatment that some had hoped it to be - but the Fed has created an environment in which equity valuations are inflated.
It's a warning, though. Powell and company can influence the macro, but not the micro. As corporate profit growth turns to the negative in the first quarter, all the money in the world - or M2 in the U.S. - cannot change the fact that rising stock prices and falling earnings make the market more expensive.
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