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Hedgeye Guest Contributor | Thornton: Is the Fed Waking Up To Reality?

Editor's NoteBelow 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. 


Please note that while the views expressed in this column do not necessarily reflect the opinion of Hedgeye, Thornton's analysis is hard-hitting and provocative. A must-read for thoughtful investors.


Hedgeye Guest Contributor | Thornton: Is the Fed Waking Up To Reality? - Fed grasping cartoon 01.14.2015


In a speech on May 26, Fed Governor Jerome Powell noted that “A long period of very low interest rates could lead to excessive risk-taking and, over time, to unsustainably high asset prices and credit growth.”


One cannot help but wonder what Governor Powell considers to be a “long period.” The federal funds rate quickly headed to zero when the Fed increased the monetary base by making loans to financial institutions following Lehman Bros. bankruptcy announcement on September 15, 2008. The Federal Open Market Committee (FOMC) slowly reduced its target for the funds rate from 2% to effectively zero by December 15, 2008, in spite of the fact that the funds rate was already near zero, see "Requiem for QE."


The funds rate target remained at this level for SEVEN years before the FOMC increased the target to between 25 and 50 basis points on December 16, 2015. So the funds rate has been excessively low for nearly 7.5 years. This is unprecedented, and an extremely long period.

I am also struck by Powell’s suggestion that “very low interest rates could lead to excessive risk-taking and, over time, to unsustainably high asset prices and credit growth.” It’s already happened! The FOMC’s low rate policy has already led pension funds and retirees to take excessive risks.


It has also produced unsustainably high asset prices as evidenced by this graph from "My Scary Chart." The figure shows household net worth as a percent of disposable income. The first two peaks were due to unsustainable increases in assets prices: The first, to equity prices, the second to home prices.


Hedgeye Guest Contributor | Thornton: Is the Fed Waking Up To Reality? - waking up


The third is due to a combination of equity and home prices. This rise in household wealth also seems to be unsustainable. The question is: Does it decline slowly to the trend line or does it fall precipitously like the previous two?


The FOMC’s policy has already caused banks to make an extraordinary quantity of loans in a slow growth economy and has caused the M1 money supply measure to more than double since Lehman’s announcement, see Excess Reserves and Excessive Risk Taking.

Powell appears to be waking up to the consequences of the FOMC’s policy. He concluded his speech with, “My view is that a continued gradual return to more normal monetary policy settings will give us the best chance to continue to make up lost ground.” However, he is yet to come to the realization that the return to “normalcy” needs to happen quickly not gradually. Waiting two or more additional years won’t improve the economy; it can only cause further harm.

May-hem? | About That Bottom ...

May-hem? | About That Bottom ... - Bull case cartoon May 2016


We profiled the Jobs report in this morning’s Early Look and on The Macro Show and you needn’t go much deeper than the headline to capture the larger flavor of the May release, so we’ll leave it to others to split hairs on the internals.


Apart from the NFP data, we thought a couple other quick callouts were worth a highlight:


About that Bottom | ISM adds Insult to NFP Injury:  While Manufacturing PMI’s have been putting in an alleged "bottom" for a year now, the bottom continues to fallout of the ~4/5th of the economy that is Services.  


Today’s (still poorly named) ISM Non-Manufacturing report (calling the vast majority of the economy “Non-Manufacturing” is, to quote Garnett Williams, like referring to the bulk of zoology as the study of nonelephant animals) showed expansion in the Services Sector slowed to its weakest pace in 27-month in May at 52.9. 


The drop was ubiquitous across the primary sub-indices with New Orders matching a 27-month low, Employment falling into Contraction, Backlogs dropping to 50-even and Export demand cratering -7.5pts sequentially to 49.0.  


A lower-low, by defnition, is not a bottom.  


Seasonality:  We re-highlighted the topic of seasonality in April in today’s Early Look.  Specifically, the fact that the reported April data showed some of the largest sequential increases in years across a number of primary domestic macro series (NHS, PCE, Retail Sales, etc) occurred, incidentally, alongside the infrequent, compound benefit of 5 weekends + the Easter shift – effectively giving April a 40% increase in high consumption weekend days.  


We’ve looked at historical incidences of the same calendar dynamic that characterized this April and while the tendency is for some measure of hangover in the subsequent month, the sample size isn’t particularly large and is subject to other externalities (i.e. recessions, regulatory changes, etc).  


A relevant empirical question here – with employment, services activity and confidence reports for May all sliding moderately-to-severely in May – is whether the April data was more headfake than harbinger and whether it was the 'escape velocity' or 'statistical distortion' stars that were aligned to start 2Q. 


Barring revision, the April data will help buttress reported growth in 2Q but the early balance of May data suggest May-laise will largely offset the April exuberance.


 ..... another noodle to noodle over this weekend as you noodle over the Fed’s requisite noodling over lagging economic data. 


May-hem? | About That Bottom ... - ISM NON MANUFACTURING PMI


May-hem? | About That Bottom ... - ISM Services Headline New Orders


May-hem? | About That Bottom ... - ISM Services LT


May-hem? | About That Bottom ... - ISM Services Summary Table


May-hem? | About That Bottom ... - NFP YoY


May-hem? | About That Bottom ... - Employment Summary Table



Christian B. Drake


Remember This? McCullough On Fox Business: "Jobs Growth Is Slowing" (11/6/15)

Takeaway: Today's NFP report is a certified train wreck for the "economy is improving" crowd.

Oh how the tables have turned...


Today's #JobsBomb was downright terrible. Vomitous. And to be clear, virtually no one on Wall Street saw this coming ... except of course our Macro team. 


Rewind to November. Outspoken Hedgeye CEO Keith McCullough was on Fox Business. He was warning viewers about the risks of #EmploymentSlowing, while most pundits were applauding the "Where's Waldo" Jobs Report that showed a non-farm payroll number of 271,000. In the clip above, McCullough laid out our call on #TheCycle and why the U.S. economy is sliding off its peak.


By the way, back then the 10-year Treasury yield was at 2.32%.

Today? 1.72%.

Yes, U.S. growth is slowing.

yes. we called it.

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Jobs Bomb = Fed Dovish? = December Rate Hike?

Takeaway: Yesterday, markets predicted a more than 50% chance of a July rate hike. Now, rate hike expectations don't get above 50% until December.

Jobs Bomb = Fed Dovish? = December Rate Hike? - Jobs.rate hike cartoon 11.04.2015


The #JobsBomb (a.k.a. the May Non-Farm Payroll number of 38,000) just shocked Old Wall consensus.


How do we know?


Take a look at investor's most recent expectations for a Fed rate hike. Yesterday, markets were predicting a more than 50% chance of a July rate hike. Now, rate hike expectations don't get above 50% until December.


What a difference a day can make...



Jobs Bomb = Fed Dovish? = December Rate Hike? - rate hike prob 6 2



Jobs Bomb = Fed Dovish? = December Rate Hike? - rate hike prob 6 3


We're not surprised. We've been saying #EmploymentSlowing for a while now.


When will the Old Wall learn?

Daily Market Data Dump: Friday

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




Daily Market Data Dump: Friday - equity markets 6 3


Daily Market Data Dump: Friday - sector performance 6 3


Daily Market Data Dump: Friday - volume 6 3


Daily Market Data Dump: Friday - rates and spreads 6 3


Daily Market Data Dump: Friday - currencies 6 3


Hedgeye Potomac is hosting a call with Alexander Nicoll to discuss Brexit – will the UK vote to stay or leave the EU on June 23rd? 


Nicoll will discuss the events leading up to the UK vote and what the outcome of the vote spells for the UK and EU.  (Hint: he believes the UK will ultimately vote to Stay...).


The call will take place on Wednesday, June 8th at 11am ET with Nicoll giving prepared remarks followed by Question & Answer.




  • How did the UK get to a vote and where do the divisions lie between political parties?
  • What are the arguments for staying and leaving?
  • Who will win?
  • What are the financial, political, and cultural impacts on the UK from Brexit?
  • What’s the impact of Brexit on the EU and Eurozone?  Could another country vote to break free?




Alex Nicoll is a Consulting Member of the International Institute for Strategic Studies, a London-based think-tank. Previously he was a member of the Directing Staff of the Institute as Director of Editorial, and also headed the defense program.  Before joining the IISS he was a journalist at the Financial Times newspaper for 18 years, with posts covering international capital markets, Asia, and defense. Earlier, he was a foreign correspondent for Reuters news agency, with posts in Hong Kong, Paris, Tehran and New York. 


Ping for more information.

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