As anticipated, the hurricanes have turned the usual flow of economic data into a game of Pick-Up-Sticks, a meaningless tangle. The market reaction has been to ignore the new data, assume the economy is on-trend, and focus on other stuff which may be trend-changers.
That other stuff would be the Fed, foreign policy, trade policy, and asset markets.
The Fed is in play in two parts: what it will do and who will do it. The consensus now: in December the Fed will lift the overnight cost of money from 1.25% to 1.50%, and that move is largely built into mortgage and other market rates. However, we are nearing the end of the period in which the Fed could hike and long-term rates could stay put. The 10-year T-note has been hanging on to a key level all week -- 2.35% -- which is too low relative to the fed funds rate to survive another hike. Mortgages are now back just above 4.00%, and brace thyself.
Who will lead the Fed after Yellen... markets hope Yellen. If not Yellen, then Powell. If not Powell, Cohn. If it’s Warsh, markets will have a grumpy day but will be okay until we see what he actually does. If it’s one of the wing-nuts, like Taylor... bad, bad days ahead. There is no useful guessing at who it will be. The president sees himself as an expert on debt, but his key skills have been default and wishing for low rates.
The Fed’s future actions will be confined by events, no matter who is in the Chair. The Fed’s primary forecasting tool -- employment and wages versus inflation -- is busted, but they have other tools and concerns. One long-running one: the immense heap of cash created by global central banks may not produce traditional wage-based inflation, but could cause asset bubbles.
The central banks after 2008 intended to create rising asset values. The right-wing brain-dead have objected that this policy was a market “distortion.” That’s what central banks do: they distort markets upward in bad times to help recovery, and downward in good times to prevent overheating. However, in the aftermath of the most extreme asset collapse in history, and now recovery, we have no history to frame policy for what comes next, and are stuck with the judgment of whoever staffs the Fed. That’s the best we can do: we must rely on them, and they must act on their collective hunches.
Asset bubbles are notoriously difficult to see coming. The most traditional one is the easiest to see coming, and the one the Fed most-commonly punishes: housing. Except for apartment construction in some markets, there is no sign of a housing bubble -- which perversely complicates the Fed’s chore. If the Fed raises rates for some non-housing reason it could easily crater the non-bubble housing market.
What of other assets, stocks primarily? Begin with the obvious: nobody knows where stock prices “should” be, especially in a globalizing economy during an IT revolution, which make historical markers look like Puerto Rico’s electrical grid. But the persistent buoyance in stocks is anxious-making. This week alone, new all-time highs, broad indices up 1% against a news backdrop which should have hurt stocks: daily presidential jawbone indicating an urge to pop the DPRK and Rocket Man, a demolition derby in trade policy, canceling the nuke agreement with Iran, and the presidential solution to Puerto Rico damage by “wiping out” its $73 billion municipal bond debt. Some would argue that stock buyers are anticipating good things from tax cuts and reform, and some people will believe anything.
One good indicator of a bubble nearby is a rising market for a new fairy tale. For example, the 2004 belief that mortgage borrowers with no down payment and no proof of income or assets would perform on their loans. A comparable hallucination today is the growing market for crypto currencies. Bitcoin may have some ultimate utility because of its system of transaction settlement. But the new and fast-growing crypto subset is the “ICO,” $1.3 billion raised in the last 90 days, a 50% increase above the sum in the prior six months. Hyperbolic growth seldom has a happy ending.
An ICO is an initial currency offering by a new and inevitably technology start-up company, and the nouveau substitute for an IPO, an initial public offering of stock. In the last 90 days, 105 of these: you give us your dollars, and we give you Tezos, or TenX, or PressOne at a value which we assert and control, and of course predicated on our start-up success. China and Korea have forbidden trading in these flights of imagination. ECB board member Novotny this week: the hype around digital currencies like bitcoin is “dangerous and deeply dubious.”
Money of all kinds rests on faith. Even faith in gold was flawed, because gold-based economies fell in suicidal dominoes over and over again. But unregulated phony-money as a substitute for poor-idea stock offerings... you can bet the Fed is disturbed there is so much cash floating around that investors are lighting cigars with it.
The US 10-year T-note is technically edgy. Take out 2.40% going up, and we’ll try the post-election tops. Decline from here and we’re okay:
The Fed-predicting 2-year T-note is all set for a December hike. Still, most unusual for the early part of a Fed cycle: markets are trailing the Fed, moving up the next notch only after the Fed has made its next intentions clear. Normally (always) rates rise much faster in anticipation of the Fed’s ultimate landing spot. Today’s trailing pattern is reasonable, as the Fed says it’s only trying to remove excess stimulus, and to take out insurance against the possible need for actual tightening in the future.
GDP accounts will suffer from hurricanes, too, but not so much as the granular data. Running 2%-plus is on the hot side for the Fed, no matter what the 3%ers are dreaming:
The ECRI concurs with the Atlanta Fed: good, solid growth.