Wednesday, November 20, 2013 - Fed Minutes, Fed Conundrum

Fed Minutes, Fed Conundrum

by Sinclair Noe

DOW – 66 = 15,900
SPX – 6 = 1781
NAS – 10 = 3921
10 YR YLD + .09 = 2.79%
OIL - .01 = 93.33
GOLD – 32.40 = 1243.80
SILV - .49 = 19.95

The Federal Open Market Committee, Federal Reserve policy makers, met October 29-30, and to no one's surprise they did not change monetary policy. Today, minutes of that meeting were released. The policy makers “generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months.”

They think the economy is improving, despite the government shutdown and ongoing political dysfunction, the economy is getting better and the FOMC is considering how and when they can exit Quantitative Easing; they would like to scale back $85 billion per month in purchases of Treasuries and mortgage backed securities without triggering a rise in interest rates that could slow economic growth and wipe out gains in the labor market. That is not to say they are ready to raise their Fed Funds target for interest rates. That target has been right at zero and will likely remain at zero for at least a year or more.

They want to get out of the bond buying business without the market noticing, and independently pushing interest rates higher. It'll be a fine trick if they can pull it off.

In a speech to the National Economists Club, Ben Bernanke said: "I agree with the sentiment, expressed by my colleague Janet Yellen at her testimony last week, that the surest path to a more normal approach to monetary policy is to do all we can today to promote a more robust recovery," and he says, "The FOMC remains committed to maintaining highly accommodative policies for as long as they are needed."

Exactly how long the accommodative policies will remain in place is the $85 billion dollar question; the market is now guesstimating the Fed won't taper till March or maybe January. The idea is that they will wait for signs that the economy is strong enough to finally reach escape velocity. We're not there yet.

The National Association of Realtors reported that home re-sales fell 3.2 percent last month from September to a seasonally adjusted annual pace of 5.12 million. That's down from a 5.29 million pace in September and the slowest since June. A healthy pace is around 5.5 million. Sales of single family homes declined 4.1 percent, while condominium sales rose 3.3 percent. The median sales price of an existing home was $199,500 in October, up 12.8 percent from a year earlier and the 11th straight month of double-digit annual increases.

The 16-day partial government shutdown pinched home sales last month by creating uncertainty about the economy and slowing loan approvals: 13 percent of real-estate agents reported that transactions had been delayed. Now, that might just mean that sales were postponed, and they'll pick up in the next report, or it might signal a plain old slowdown.

The Fed's bond purchases have kept long-term interest rates low. Mortgage rates are still low by historical standards, but interest rates began to rise in late May on speculation the Fed would slow its bond purchase program. Add to that the idea that many younger potential home buyers, or first time buyers saw the carnage of 2006 and 2007 and they just aren't interested. In this past month's report, first time buyers accounted for 28% of sales, down from around 40% in healthier housing markets.

Cash purchases made up 31 percent of October's sales. This might indicate that the Fed's easy monetary policy has only been easy between the Fed and the banks. So, this gets right to the Fed policy makers' conundrum; how can they withdraw easy money from the markets without creating a slowdown; if the Fed stops buying mortgage backed securities, that would almost certainly make it even tougher to get a mortgage and the housing market would surely suffer.

One idea is to counter any taper of asset purchases by reducing the interest rate on funds that banks keep on deposit with the Fed. That's right, the Fed not only buys mortgage backed securities from the banks, but then they pay the banks to keep funds on deposit with the Fed, essentially discouraging the banks from taking the money and lending it out in the community and into the economy. This is something that might be a small step, worth considering, but the reality is that any Fed taper from QE will be met with a taper tantrum, and for now the Fed doesn't want to rile the markets.

This is not to suggest the economy is horrible; the Fed's assessment of a growing economy was reinforced with a report this morning that consumer spending rose in October, despite the shutdown, and suggesting upside momentum heading into the fourth quarter. Retail sales excluding automobiles, gasoline and building materials increased 0.5 % last month after advancing 0.3% in September. Overall retail sales rose 0.4% after being flat in September. Core retail sales last month were bolstered by gains in receipts at clothing, furniture, electronics and sporting goods shops, among others. Sales at electronics and appliance stores rose by the most since April.

Meanwhile, the Labor Department reported that inflation is a bit less than optimal; the Consumer Price index dipped 0.1% last month as gas prices dropped, after rising 0.2% in September; this was the first decline in 6 months. In the 12 months through October, the CPI increased 1.0%, the smallest gain since October 2009.

Stripping out the volatile energy and food components, the core CPI edged up 0.1%, rising by the same margin for a third consecutive month. Over the past 12 months, the core CPI increased 1.7%, matching the previous month's rise. A reminder that the Fed targets inflation at 2%; that's the level they want; less than 2% indicates a greater concern that disinflation could lead to deflationary pressures. All the more reason for the Fed to continue with its easy money policies.

The other target, or guidance, offered by the Fed is that they will stick with easy money until the unemployment rate hits a target of 6.5%; in last night's speech, Fed Chair Ben Bernanke, indicated that it is still a target but it doesn't mean that if the target is hit, it will automatically change anything. Bernake said:

“In the judgment of the Committee, the unemployment rate--which, despite some drawbacks in this regard, is probably the best single summary indicator of the state of the labor market--is sufficient for defining the threshold given by the guidance. However, after the unemployment threshold is crossed, many other indicators become relevant to a comprehensive judgment of the health of the labor market, including such measures as payroll employment, labor force participation, and the rates of hiring and separation. In particular, even after unemployment drops below 6-1/2 percent, and so long as inflation remains well behaved, the Committee can be patient in seeking assurance that the labor market is sufficiently strong before considering any increase in its target for the federal funds rate.”

Bernanke went on to say:

“When, ultimately, asset purchases do slow, it will likely be because the economy has progressed sufficiently for the Committee to rely more heavily on its rate policies, the associated forward guidance, and its substantial continued holdings of securities to maintain progress toward maximum employment and to achieve price stability. In particular, the target for the federal funds rate is likely to remain near zero for a considerable time after the asset purchases end, perhaps well after the unemployment threshold is crossed and at least until the preponderance of the data supports the beginning of the removal of policy accommodation.”

The Dow just skirted 16K and virtually the entire run-up of the stock market is based on one thing, and one thing only, the Fed pumping money into the markets.  That is it, that is all.  Since the market bottom the market has more than doubled, but jobs aren’t even close to recovering as a percentage of the population, Europe is still in crisis, and oil prices are still ludicrously high. You cannot have profits higher than actual productivity increases plus inflation plus population increase.  Anything more than that is not profit, it is fraud, underinvestment in real capital or it is diverting future profits to the present.

 The problems the economy has cannot be fixed by giving more money to banks and rich people and attempting to turn the housing market into a cash cow again. The economy requires targeted spending, to get off oil, to break up the big banks and other oligopolies, to open up the economy to actual competition, and to increase the pricing power of labor and reduce the pricing power of employers while making sure they don't run up against supply bottlenecks.  It does not require giving money to people who will simply use that money for more leveraged financial plays or to bury bad assets on balance sheets at mark to make believe.

To the extent a market works it must be regulated to be competitive, and assets must not be allowed to pile up in a few hands.  Financial profits cannot be allowed to be higher than non-financial profits, and the labor market must be tight, so that people are free to move away from jobs they hate (if your employees hate their jobs they should either be very well paid because the job is absolutely necessary, or it shouldn’t exist at all.) And the employees who are actually working need enough to actually live on. Did you hear about the Wal-Mart in Ohio that held a Thanksgiving food drive – for their own employees?

Whatever the Fed is doing or thinking about doing, the first step should be acknowledgment that the trickle down wealth effect from the housing market and the stock market is limited, very limited. As for the stock market, it is in fantasy land, entirely a creature of the Federal Reserve, almost completely divorced from the actual economy. Of course, the stock market can remain irrational longer than you can remain solvent.