Is the Fed Seeing a Mirage?

Wall Street doesn’t want to believe it, but money rarely falls from the sky. Anyone who thinks otherwise is probably seeing a mirage.

The Federal Reserve’s Quantitative Easing program isn’t a mirage, of course. It is all too real — but it might end this week. What will the end of QE mean for your non-imaginary money?

Money mirage

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On Oct. 28, Tuesday morning, Janet Yellen will gavel the Federal Open Market Committee to order for its latest two-day gabfest. The FOMC sets monetary policy — which for the last six years mostly meant, “Print More Money!“

Fed officials now say they want to “normalize“ policy. That means the Fed will stop buying bonds and slowly start raising interest rates. They say the economy can stand on its own feet now.

Should we believe them? I’m not sure they believe it themselves. Yes, they want to end QE, but not because it worked. They’re going to end QE because it didn’t work and is probably starting to backfire.

Today’s Wall Street Journal carried an interesting opinion piece by Romain Hatchuel, a money manager in New York. The title is The Fed Rate Hike May Be a Mirage. You may not be able to read it unless you are a WSJ subscriber, so I’ll give you a short summary.

Here is how Hatchuel begins.

For six years the Fed has bought trillions of dollars’ worth of U.S. Treasuries and mortgage-backed securities in an attempt to jump-start the U.S. economy. As a result, its balance sheet has increased to a record 25% of the nation’s gross domestic product—higher than at the end of World War II or at the heart of the Great Depression. Attention has already shifted to future interest-rate hikes, the next logical step in this dreaded tightening cycle, which the market believes will begin somewhere between the middle of next year and the beginning of 2016.

Those who have criticized what they consider a period of monetary lunacy will praise the normalization of Fed policy. Others will lament it and issue dire forecasts. Yet, there is every reason to believe that this month’s highly anticipated end to so-called quantitative easing will be nothing more than a tactical retreat by the U.S. central bank, and that next year’s rate increase won’t materialize.

Hatchuel goes on to give five reasons the Fed won’t raise rates next year:

  • The U.S. economy remains stubbornly weak. The Fed itself has cut its 2014 forecast from 3% last December to 2.1% now. Some economists think this is optimistic. If force-feeding trillions of dollars into the economy can’t produce any more growth than that, it is hard to see how raising interest rates will help.
  • Europe is going into recession and/or deflation. The European Central Bank released its latest bank stress test results over the weekend. The good news is that Europe’s banks seem generally stable. The bad news is no one in Europe wants to borrow money from them.
  • China’s slowdown will keep the developing world from bailing out the West. Yes, 7.3% annual growth is nothing to sneeze at, but the growth trend is what counts. China is retrenching, which means resource-driven economies like Brazil will slow down even further.
  • The strengthening U.S. Dollar will hurt U.S. exports, making higher U.S. interest rates a risky move. A stronger dollar makes it more expensive for foreigners to buy U.S. goods. The dollar will get even stronger if the Fed hikes rates. A competitive currency war with Europe and Japan is more likely.
  • Finally, any number of events could set off a market shock: Ebola, Russian aggression, a large bank collapse, Mideast instability, you name it. Raising interest rates are rarely the best response in those situations.

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I don’t believe any of these factors will change the Fed’s mind on QE. They will almost certainly take the program down to zero this month. The bigger question is when they will actually raise their benchmark Federal Funds rate.

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Right now, the consensus is they will hike rates in the second half of 2015. I don’t think it will happen, except maybe as a small test-the-waters move.

What do you think? Can the economy stand higher rates? Is the Fed out of bullets? How will it affect stocks and bonds? You can leave a comment on our website or send me an e-mail.

We’ll get the Fed’s QE3 verdict at 2 p.m. EST on Wednesday, Oct. 29. You have between now and then to make sure your portfolio is ready.

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U.S. stock market gauges were mixed today in slow Fed week trading. The main driver was weakness in the energy sector.

  • Goldman Sachs (GS) issued a bearish outlook for oil prices and energy shares. Wall Street saluted and followed orders.
  • West Texas Intermediate crude broke below $80, with the spot December contract trading as low as $79.44 before moving back over the line.
  • Low oil prices pummeled energy stocks, especially energy service names like Halliburton (HAL) and Nabors Industries (NBR). HAL dropped 6.1% while Nabors closed with a 6.7% daily loss.
  • On the positive side, the Lundberg Survey said average U.S. retail gasoline prices are at the lowest level since December 2010, almost four years ago.
  • Ebola fear went political over the weekend as several state governors decided to tighten quarantine requirements despite White House objections.
  • A five-year-old boy is under observation in New York’s Bellevue hospital for possible Ebola infection. News reports said he had been with his family in West Africa within the last 21 days.
  • Apple’s (AAPL) new iPhone payment system is hitting resistance from retailers. Drug chains CVS and Rite-Aid along with Wal-Mart (WMT) stopped accepting Apple Pay even though their store terminals support it.
  • A retail consortium is working on a competing smartphone payment app and its members apparently fear giving Apple a head start. Their own app won’t be ready until sometime next year.

Good Luck and Happy Investing,

Brad Hoppmann

Publisher

Uncommon Wisdom Daily

 

Your thoughts on “Is the Fed Seeing a Mirage?”

  1. As I see it, the Fed’s Quantitative Easing over the past five years has created a lot of fiat currency through the creation of a flood of public debt, but little of that money has actually entered the real economy of “Main Street America”. By design and government complicity, the money has enriched “Wall Street” and there it remains. No wonder America and the rest of the developed world have been merely treading water economically since the 2008 collapse of the credit markets.

    When we are hit with another major market collapse and another devastating depression, only then are we likely to see all this money deployed by Wall Street and its cronies to buy up what remains of a free America….10 cents on the dollar. In the meantime, little growth, no real wage increases, and few new jobs of any note because Main Street doesn’t have the money or the confidence to make it happen. Only an exploding, crippling, public debt which the tax payer and his children’s children will be obligated to repay with no means to do it.

  2. Plenty to think about. I have a hard time every time I hear that the economy is recovering. In the real world, I just don’t see it. No job creation, massive corporate taxes, people in record numbers giving up their American citizenship, Hillary Clinton telling her constituents that business don’t create jobs and people actually applauding….I could go on. The show “Shark Tank”, has created more jobs then the United States government.

    The old saying…..for a ship without a helmsman…. no wind is a good wind, most certainly applies to our leaderless country.

    Obama will pull off the greatest magic trick in history; making a once great country disappear before everyone’s eyes. He will increase interest rates, at the end of his second term. It will be like waving his magic wand and the economy will crumble and the United States of America disappears from the world stage.

    Gonna go and watch the Cowboys hopefully get their butts kicked.

  3. The New York boy tested negative, according to evening news, but local news says someone is being taken to University of Maryland Medical center in Baltimore for testing as I write. They have isolation facilities. We will see.

    As for the Fed, my guess is, no raising interest rates for awhile, but, if the U.S. economy doesn’t show more definite strengthening within a few months or so, something like a modified QE4 may be trotted out.

  4. As usual no one knows what is going on or where things are headed. So the best advise is to diversify
    and not give up the day job. Diversity means life beyond the stock/bond market… get a large plot in a
    community garden and learn how to store food (be sure to learn how to grow food first as this comes before
    harvest and storage). Put off any thought of divorce as having a working mate (male or female or some combination) during uncertain times
    can prove valuable. Forget about a second home and concentrate on hanging onto the first home.
    Don’t buy stocks–just sell a lot of puts.If the market goes up you’ll have made a good profit. If the market
    drops you’ll have the stocks you would have bought in the first place at a small discount. If you don’t
    know what I’m talking about best to stay out of the market. Buy silver and pray that Tesla/Monk build a lot
    of batteries. Take a vacation and return when the air clears–if the taxi driver has ISIS tatooed on the back of
    his neck–take public tranportation and hope that an Ebola vaccine is in place before you travel very far.

  5. I believe the Fed will not be able to materially raise interest rates, because it would devastate their primary dependent, eg the United States of America. The Treasury shortened maturities in order to reduce interest expense to the government. As a result a very high percentage of the Federal debt rolls over every year. The result of the Fed raising interest rates will have immediate effect on the interest rates paid on the government’s rolled over and new debt, effectively and dramatically impact the Federal budget deficit.

  6. Hi Brad,

    I think you and every other commentator I’ve seen is missing one hugely important factor. The lower energy costs will have a positive and very large impact on the real economy unless those who hate fossil fuels screw it up. While quantitate easing may have spurred the stock market, main street has been battered since the 2008 recession began. If energy prices remain at current levels or continue to fall and if Mr. Putin doesn’t shut off natural gas to Europe and if ISIL doesn’t expand beyond Iraq and Syria the real economy could be the vehicle to push markets to record high levels.

  7. The Fed doesn’t create money.They create fiat currency,which a lot cheaper to create than money.There is no limit on Fed fiat creation,so I think the Fed has our back and will do whatever it has to,to keep real assets rising and fiat declining.They have been successfully devaluing the currency for 100 years,so have a great long term record.I’m with Buffett and almost all out of junk fiat and into ownership of great companies.

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