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Hedgeye Guest Contributor | Thornton: Will the Fed Raise Rates Before the Election?

Editor's Note: Below is a Hedgeye Guest Contributor research note written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. 

 

A brief note on our contributor policy. While this column does not necessarily reflect the opinion of Hedgeye, suffice to say, more often than not we concur with our contributors. In the piece below, Thornton writes of current Fed policymakers, "I hope that the next president, whomever that may be, has the foresight to change the guard."

 

Hedgeye Guest Contributor | Thornton: Will the Fed Raise Rates Before the Election?  - Fed Chairmen cartoon 02.03.2016

 

“Facts are stubborn things”

-John Adams

 

CNN Money posted this headline on April 27: Will the Fed raise rates before the elections?

 

The correct response, of course, is: Who cares?

 

The reality is that no one should because a 25 basis point move is irrelevant for economic activity. One would only care if one believes that raising the target for the funds rate is a signal that the Fed will shrink its balance sheet back to the point where bank excess reserves are once again trivial—about $2 billion. But, of course, the Fed is not poised to do that anytime soon. Instead, the Fed will continue to make tiny, 25 basis point, adjustments to its funds rate target.

 

More troubling, markets will continue to believe that the Fed (the European Central Bank, and other central banks) have considerable control over interest rates beyond the essentially meaningless federal funds rate. If this were not the case, CNN Money would never post such a headline.


As I pointed on in a previous Common Sense Economics Perspective, the Fed’s ability to affect interest rates stems, in part, from the fact that price discovery in the credit market is difficult. Hence, lenders are looking for an anchor for their lending rates. The belief that the Fed can control interest rates provides such an anchor. Indeed, this belief has allowed the Fed to control the federal funds rate very tightly simply by announcing its target for the rate—no actions were required.

 

I am sympathetic with my economist friends who find it difficult to believe that the Fed has been able to control the funds rate simply by announcing the target and, in so doing, has distorted interest rates on a variety of assets: Can the Fed have such power simply because market believes that it has it?

 

The evidence I have found elsewhere, plus the previously mentioned difficulty of price discovery in the credit market strongly suggests the answer is, yes! Specifically, I show that the Fed controlled the funds rate with open mouth operations, not open market operations, and that, in so doing, distorted Treasury yields along the yield curve out to five years.

 

Hence, I am not surprised that the Fed’s 7-year zero interest rate policy, and its quantitative easing, forward guidance, and Operation Twist policies have had even a larger detrimental effect on interest rates in the broader credit market. The distortion of interest rates is detrimental because it causes credit to be allocated differently than it would have been otherwise. Policymakers should interfere with the allocation of credit if, and only if, they can allocate credit better than the market can. I don’t believe that this is ever the case.


The bottom line is this: Any economist worthy of the name knows that the Fed can only have a significant effect on interest rates if the market believes that it can. Hence, interest rates could return to more normal levels if the Fed would simply admit that this is true. Of course, this cannot happen under current Fed leadership because it is too heavily invested in the policies of the last 7+-years.

 

This can only happen with a changing of the guard. I hope that the next president, whomever that may be, has the foresight to change the guard.


Earnings Season: U-G-L-Y (You Ain't Got No Alibi, You Ugly)

Takeaway: A total of 374 of 500 S&P 500 companies have reported Q1 results with aggregate sales and earnings growth down -2.7% and -8.8% respectively.

Earnings Season: U-G-L-Y (You Ain't Got No Alibi, You Ugly) - earnings cartoon 01.27.2015

 

It's been an ugly earnings season.

 

Some important callouts this morning:

  • A grand total of 374 of 500 S&P 500 companies have reported Q1 2016 results, with aggregate sales and earnings growth down -2.7% and -8.8% respectively;
  • So far... 7 of 10 sectors have reported negative earnings growth;
  • Earnings growth for our favorite sector short call, Financials (XLF), are down -13.8% with sales -4.0%;
  • Energy (XLE) earnings growth crushed, down -99.5%, with -30.7% sales growth;

 

Here's what it looks like right now.

Earnings Season: U-G-L-Y (You Ain't Got No Alibi, You Ugly) - earnings 5 5


Daily Market Data Dump: Thursday

Takeaway: A closer look at global macro market developments.

Editor's Note: Below are complimentary charts highlighting global equity market developments, S&P 500 sector performance, volume on U.S. stock exchanges, and rates and bond spreads. It's on the house. For more information on how Hedgeye can help you better understand the markets and economy (and stay ahead of consensus) check out our array of investing products

 

CLICK TO ENLARGE

 

Daily Market Data Dump: Thursday - world equity markets 5 5

 

Daily Market Data Dump: Thursday - sector performance 5 5

 

Daily Market Data Dump: Thursday - market volume 5 5

 

Daily Market Data Dump: Thursday - rates and spreads 5 5


Early Look

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Relied upon by big institutional and individual investors across the world, this granular morning newsletter distills the latest and most vital market developments and insures that you are always in the know.

CHART OF THE DAY | FYI: Employment Growth Peaked In Feb 2015

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to learn more. 

 

"... if NFP (non-farm payrolls) ramps to a rate-of-change acceleration ABOVE last year’s peak growth rate (+2.3% year-over-year NFP growth), my conviction on US #GrowthSlowing could fall below 66%, but would have to TREND that way."

 

CHART OF THE DAY | FYI: Employment Growth Peaked In Feb 2015 - 05.05.16 EL Chart


What To Watch Ahead Of Friday's Jobs Report: U.S. Dollar & Oil

What To Watch Ahead Of Friday's Jobs Report: U.S. Dollar & Oil - Jobs report cartoon 06.04.2015

 

"We're seeing very short-term oversold signals in US Equity Beta yesterday (see Real-Time Alerts for details)," Hedgeye CEO Keith McCullough wrote this morning in a note sent to subscribers this morning. Here's more from McCullough:

 

"One of the main reasons for the oversold SPY signal was the super-short term overbought signal in USD (2 USD up days rocked reflation beta, but on a bad jobs report tomorrow, USD can easily retrace to 16 month lows); 90-day inverse correlation b/t SPY and USD is -0.62, so it’s not the layup that buying oil/energy stocks has been (higher correlation), but it’s there."

 

 

Digging deeper into oil...

 

"Big bounce +3.3% on Dollar Down move as WTI holds the low-end of our immediate-term $42.34-46.63 risk range and that’s all it’s signaling to me here – short-term range bound with long-term TAIL risk in that $46-47 range."

 

 

Ahead of Friday's down Dollar jobs report, that's why McCullough sent out the buy Energy (XLE) signal in Real-Time Alerts late yesterday.

 


Cartoon of the Day: Red, White & Blew It

Cartoon of the Day: Red, White & Blew It - Fed cartoon 05.04.2016

 

“A rate hike could be appropriate, if the data is as expected," San Francisco Fed Head John Williams remarked yesterday. As Hedgeye CEO Keith McCullough wrote in today's Early Look, "Given that a recently reported GDP of 0.5% isn’t in the area code of “as expected”, I don’t think Williams has a lot of credibility as a Wall Street forecaster."


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