One wonders with the inept Fed chairman we have today -- with record unemployment and U.S. GDP growth around 1.8%, and when a mere slowdown hiccup makes him stutter and go "erhmm" and "ahhh" to simple press questions -- what would happen if the U.S. economy underwent another Lehman-type crisis or worse, a Repo crisis? He makes Ben Bernanke look like the Iron Man! We are in perilous times and we have a Fed Chairman who is led astray by his President's angry tweets. The least he could do is defend his stance with confidence, rather than shuffle around with his tail between his legs.
The long-awaited Fed September FOMC meeting came and went. The U.S. Fed cut benchmark interest rates by 25 basis points (bps), as expected, but the commentary that followed afterwards was a tad bit hawkish. The market, doped up on a Fed free money liquidity rush, expected a 50 bps cut and/or a launch of Quantitative Easing (QE), so this proved to be a disappointment. With the S&P 500 trading at 3000 and economic data reporting where it is, it is astonishing to even hear such expectations, but investors know no other way than to "Buy-the-Dip" and "Fed will always provide a floor" without understanding the consequences.
It seems President Trump's strategy has worked: Chastise the Fed on a daily basis, compelling them to cut rates as much as they can. In tandem, keep imposing tariffs on the entire world including China, causing even more disruption in the supply chain to give them enough ammunition to do so.
The data has been weakening no doubt, but it does not warrant the Fed going guns blazing cutting rates down to 1% and starting QE4.
What most people do not realize is that the Fed has always been a backward-looking institution, they have never, nor will they ever have the tools or the predilections to be able to make a forward-looking call. Case in point is 2008, when Ben Bernanke sat in front of the FOMC press committee positing "we do not see a case for a recession" when just one month later, Lehman Brothers collapsed and world fell into financial Armageddon. Could this September FOMC be Powell's "Bernanke moment"? Only time will tell.
President Trump and Xi Jinping are due to meet on October 1 to resume trade talks, once again. Powell yesterday only cited global growth and trade uncertainty as risks in the future for the expansion. He commented that the economy was robust and labour market strong. In effect, he is hedging the global economy given how important the dollar is to the rest of the world. The entire institution became a mockery when, after reducing the balance sheet by $1.5 trillion, the economy started to crumble.
Inflation is Powell's Achilles heel, as these things take time to show up in the economic data. The Core CPI and breakeven rates all imply inflation is rearing its ugly head and slowly ticking higher. This will limit how much Powell can cut or should cut, lest he wants to stoke stagflation and take us all the way back into the 1970s. Growth is moderating, inflation is moving higher. This is not a healthy balance for investment in equities or any risky assets. Investors only see and hear what they want to, but this bears monitoring.
The Repo (repurchase agreement) market has been in utter chaos over the past week. There is serious liquidity problem in the short-term dollar funding markets. Cash available to banks dried up and interest rates shot up to 10% for some overnight loans, around 4x the Fed's rate! This is not a sign of a healthy market, but that memo has not gone out to the algorithm strategies and equity market punters.
The Fed had to inject about $125 billion in liquidity over the past 2 days to calm the market, but this was not enough to stop the rate from staying above the Fed's targeted 2%-2.25% range. On Wednesday, there was about $80 billion in demand when the Fed only injected $75 billion; some bank fell short! What caused this is yet a mystery, as it could have been corporations withdrawing money to pay their quarterly tax bills or banks who had to pay up for all the U.S. Treasuries they bought over the past week sold by Uncle Sam.
The U.S. market has been in a tight range over the past few months, oscillating between 2900 and 3000, Wednesday and threatened to break to the downside following Powell's lame statement, but then shot up higher as the market cheered signs of QE4 starting. The Fed chair said he would consider balance sheet growth, but did not say when or at what level. Markets may need to retrace and fall a lot more before that option is considered.
Meantime, as equities stay flat, there is a lot happening underneath the hood as violent sector rotation hurts Long/Short Hedge Funds. Corporate profits are slowing, margins peaked. The dollar will continue to stay strong, capping commodities and cyclical equities for now. Trump has an election in one year to work towards. Will he soften his stance or agree to a fake deal to save face? The Trade War saga unfolds.