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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.


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.


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...

6/2/2016

 

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

6/3/2016

 

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?


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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

 

CLICK TO ENLARGE

 

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


About Everything | Q&A with Neil Howe: Everything Must Go

In this complimentary edition of About Everything, Hedgeye Demography Sector Head Neil Howe discusses why department stores are slowly fading away. "The downward arc started well over a decade ago—long before the Great Recession," Howe writes. "In fact, you need to go back to the Clinton ‘90s to find a really healthy growth year for department stores... Those days are long gone."

 

Click here to read Howe’s associated About Everything piece.


CHART OF THE DAY: What To Watch Ahead Of Today's Jobs Report

Editor's Note: Below is a brief excerpt and chart from today's Early Look written by U.S. Macro analyst Christian Drake. Click here to learn more.

 

"... As we’ve highlighted, just because we’re charged with generating high-frequency macro commentary doesn’t mean the slower, temporal progression of the cycle ceases to exists. As the Chart of the Day below illustrates, our larger, late-cycle point is simply that once we roll past peak rate-of-change in payroll growth, it’s a one way street towards convergence with 0%. The period of the cycle is years and historical precedents suggest some further runway in the present employment expansion but the slope of the line has now been negative for 15 months and the baseline expectation should be for that to continue to play itself out in autocorrelated fashion to the downside."

 

CHART OF THE DAY: What To Watch Ahead Of Today's Jobs Report - CoD employment Growth


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