Moving Goalposts


The equity melt-up continues, with the S&P 500 now up more than 25% year-to-date in a period of stagnant growth and an environment of declining market liquidity. The catalysts for the latest leg up were the comments and testimony by Fed Chairman-nominee Janet Yellen, whose confirmation hearings began today.

Her comments should alleviate any fear that Yellen will be anything other than the most dovish Fed Chairman in decades. Ordinarily, potential central bankers take advantage of confirmation hearings to burnish their monetarist and hawkish credentials, in much the same way that Presidential candidates always seem to try and campaign as moderates. It makes sense to do so, since the credibility of a central bank has long been considered to be related to its dedication to the philosophy that low and stable prices promote the best long-term growth/inflation tradeoff. Sadly, that no longer appears to be the case, and Janet Yellen should easily be confirmed despite some very scary remarks in both the scripted and the unscripted part of her hearing.

In her prepared remarks, Yellen commented that “A strong recovery will ultimately enable the Fed to reduce its monetary accommodation and reliance on unconventional policy tools such as asset purchases.” Given half a chance to repeat the tried-and-true mantra (which Greenspan used repeatedly) about the Fed balancing its growth and inflation responsibilities by focusing on inflation since growth in the long run is maximized then inflation is low and stable…Yellen focused on growth as not only the primary but virtually the only objective of the FOMC. As with Bernanke, the standard which has been set will be maintained: we now use extraordinary monetary tools until we not only get a recovery, but a strong recovery. My, have the goalposts moved quite a lot since Volcker!

That means that QE may indeed last forever, since QE may be one of the reasons that the recovery is not strong (notice that no country which has employed QE so far…or ever, as far as I know…has enjoyed a strong recovery). In a very direct sense, then, Yellen has declared that the beatings will continue until morale improves. And I always thought that was just a saying!

I would call that borderline insanity, but I am no longer sure it is borderline.

Among other points, Yellen noted that the Fed is intent on avoiding deflation. In this, they are likely to be successful just as I am likely to be successful in keeping alligators from roosting on my rooftop. So far, there is no sign of it happening, hooray! I must be doing something right!

Yellen also remarked that the Fed might still consider cutting the interest it pays on banks’ excess reserves, or IOER. The effect of this would be to release, all at once, some large but unknown quantity of sterile reserves into the transactional money supply. If there was any question that she is more dovish than Bernanke, there it is. It was never clear why the Fed was pursuing such a policy – flood the market with liquidity, and then pay the banks to not lend the money – unless the point was merely to reliquify the banks. It is as if the Fed shipped sealed crates of money to banks and then paid them rent for keeping the boxes in their safes, closed. If you’re going to do QE, this is at least a less-damaging way to do it although it raises the question of what you do when you need the boxes back. Yellen, on the other hand, is open to the idea of telling the banks that the Fed won’t pay them any longer to keep those boxes unopened, and instead will ship them crowbars. This only makes sense if you really do believe that money causes growth, but has nothing to do with inflation.

The future Fed Chairman also declared that the Fed has tools to avert emergence of asset bubble. Of course, no one really doubts that they have the tools; the question is whether they know how and when to use the tools. And, to bring this to current events, the question is no longer whether they can avert the emergence of an asset bubble, but whether they can deflate the one they have already re-inflated in stocks, and an emerging one in property! Oh, wait, she’s at the Federal Reserve…which means she won’t realize these are bubbles until after the bubble pops, and then will say that no one could have known.

Now, it may be that the U.S. is merely nominating Dr. Yellen in self-defense, to keep the dollar from becoming too strong or something. Last week’s surprise rate cut from the ECB, and the interesting interview by Peter Praet of the ECB in which he opens the door for asset purchases (which interview is ably summarized and dissected by Ambrose Evans-Pritchard here), keeps the heat on the Fed to remain the most accommodative of the major central banks.

At least the ECB had a reasonable argument that there was room for them to paint the least attractive house on the block. Europe is the only one of the four major economies (I exclude China since quality data is “iffy” at best) where central-tendency measures of inflation are declining (see chart, source Enduring Investments).

globalinfAnd that is, of course, not unrelated to the fact that the ECB is the only one of the four major central banks to be presiding over low and declining money supply gowth (see chart, source Enduring Investments).

globalmsStill, the Bundesbank holdovers must be apoplectic at these developments. I wonder if it’s too late to nominate one of them to be our next Fed Chairman?

There is of course little desire in the establishment to do so. The equity market continues to spiral higher, making the parties louder and longer. It is fun while it lasts, and changing to a bartender with a more-generous pour might extend the good times slightly longer.

It is no fun being the designated driver, but the good news is that I will be the one without the pounding headache tomorrow.

[Hmmm…erratum and thanks to JC for catching it. The S&P is “only” up 25.6% YTD (my Bloomberg terminal decided that it wants to default to the return in Canadian dollars). So originally the first paragraph had “32%” rather than 25%. Corrected!]

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  1. November 14, 2013 at 4:20 pm

    Great pun at the end!

    “This only makes sense if you really do believe that money causes growth, but has nothing to do with inflation” — I believe you had a nice post on that some time ago, but I just can’t find it

    • November 14, 2013 at 4:35 pm

      i write about stuff LIKE that so often it’s hard for me to narrow it down! Remember anything else about the post?

  2. BMB
    November 14, 2013 at 4:29 pm

    Reblogged this on A Bit More Bull.

  3. November 14, 2013 at 4:35 pm

    “She’s never satisfied (She’s never satisfied)
    Why do we scream at each other
    This is what it sounds like
    When doves cry”

    It is frightening that every major central bank continues to play from the same hymnal. It is clearly an article of faith that easy money is good and easier money is better. What, pray tell, defines easiest?

  4. HP Bunker
    November 14, 2013 at 5:26 pm

    Mike, If the commonly accepted “wisdom” is that a) QE will continue for a very long time, and b) it has no inflationary effects, then why do you think that stocks have diverged so significantly from treasuries and even non-equity “risk” assets such as high-yield corporate bonds, since the middle of this year and the September taper scare?

    There has been a recovery in very short term bonds (say, duration of 3 or less), but most bonds are still priced closer to their lows for the year than to their highs. It seems there is some anticipation of higher long-term rates ahead (meaning, before the Fed raises rates, which will apparently be never), coupled with a belief that said higher rates will be bullish for stocks. That sounds crazy, of course, but it seems to represent the combined opinions of the equity and credit markets…

    • November 14, 2013 at 7:48 pm

      Exhibit A, some day when I am asked to deliver a talk on efficient markets, is how the bond and stock markets often seem to be singing different tunes…a lot. I am always impressed at how seamlessly equity bulls will change stories to anything that is bullish: “coming out of recession,” “low interest rates (which are good for growth and decrease competition from another asset class),” “higher interest rates (which means the economy must be doing well, and anyway means there’s a better chance they can come down),” earnings growth, inflation hedge, etc.

      E.g., for a long time strategists were justifying high stock prices with low interest rates, even though that is explanatory and does not change the fact that high prices are followed by low returns. But now interest rates are appreciably higher, and none of these guys considers that maybe that means stocks ought to be lower. It’s another sign that there is bubble thinking going on: everything is good for stocks. Taper, no taper, slower taper, higher rates, lower rates, Yellen, Summers…

      Back to exhibit A, the usual best strategy is to completely ignore the story the stock market is telling and to trust the bond market to get it right, which they do with much higher frequency. But right now that may not work because the interest rates are purely and nakedly manipulated, rather than just nudged via the short end. I think they’re all wrong, and rates should be much higher along with inflation expectations, which implies lower equity multiples and lower prices. But the market can be irrational longer than I can stay solvent, if I bet that way. So I just accept poor returns that have lots of upside or at least lots of relative real upside.

      • HP Bunker
        November 15, 2013 at 1:56 pm

        Thanks for the reply and your take on this. What you say about bond markets “getting it right” more often that equity markets has the ring of truth to it (I would hypothesize that people find it harder to get excited about bonds with their relatively stable returns, minimizing the role of emotion in fixed income investing relative to equities), but do you know of any statistical evidence to back the statement up?

      • November 15, 2013 at 3:35 pm

        No, I don’t. I wonder how we’d prove such a statement, given that at any time it is hard to establish what the “right” really is? There is plenty of documentation for the wild swings that equities have relative to contemporaneous shifts in the fundamentals (Shiller first made his bones with that observation back in the early 1980s), but there’s also evidence that a priori estimates of real rates and inflation that are impounded in bond yields are almost never right. But that is when measured against subsequent outcomes, whereas the former is measured against contemporaneous shifts. I don’t know anyone who has looked at them both on apples-to-apples. Dissertation topic for someone!

  5. Chris
    November 15, 2013 at 2:38 am

    QE will go on until there is a STRONG recovery

    We are living really in sad times… unless we have found the perpetuuum mobile of economics.

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