The stock market’s ongoing adventure with the same banana peel has stopped the rise in long-term rates, mortgages just above 4.50%. However, no matter what happens to stocks, the upward tilt in long-term rates will continue until we get news that the economy is slowing, next month, next year, or someday.
Stocks do matter even to people who don’t own any: every news outlet in the last two weeks has led with trouble in stocks, and everyone thinks that stocks are a proxy for the economy (and sometimes it is). Reassurance is not as easy to provide, but follows here.
The fine points are crucial, and are lost in the hysteria around market movements -- hysterics both exaggerated and suppressed, especially traditional euphemistic nonsense like “correction” to describe the Dow’s worst single-day point loss ever.
There are two fine points which overlap: first is the past and current actions of the Fed, and second what the Fed will do. In the following I feel some compassion for honest commentary by people who have not seen enough cycles to get this one, and the usual contempt for those trying to make a sale by misleading or frightening civilians.
A “factoid” is an assumption or speculation repeated so often that it becomes accepted as fact (Oxford). Today’s Class-A Number-One factoid: financial markets are bloated because central banks soaked the world in cash to get us out of the Great Recession, over-did it, and as the central banks withdraw the cash financial markets will crash. Possibly below zero. Worse than climate change.
Most of that apocalyptic commentary comes from people who didn’t and don’t like the Fed’s rescue, arguing that it was unnecessary or over-done, and that the Fed didn’t create the economic recovery anyway.
The easy-money-withdrawal factoid is tempting but false. The purpose of the easy money was to get us out of recession. Once we’re out of recession we don’t need the easy money any more. The recovered economy produces plenty of support for stock markets, and proper Fed management withdraws the easy money to prevent overheating. The Fed began that recalibration five years ago by tapering and ending QE bond-buying, and continued in 2015 with the first hike in the cost of money, and last year by beginning to let bonds roll off its balance sheet.
A principle which you can count on: capitalist economies tend to enter self-reinforcing spirals, both up and down. We invented central banks (Walter Bagehot and the Bank of England ca. 1873) to intercept the spirals.
Your central bank can, of course get it wrong. Every spiral is different. But to take as factoid that the Fed switching from stimulus to not means that financial assets are overvalued and we’re all going to die... horsefeathers.
Second: what the Fed will do. There is another, milder misunderstanding loose, and I contributed to it last week and should not have. The alleged trouble in the stock market is the sudden return of wage growth and inflation, and the Fed will have to tighten faster and farther than it has said, and may already be behind the curve. That is alarmism not justified by the facts. Here is the actual sequence and the harm done to markets.
Way back at the onset of recovery the Fed began to forecast strong recovery and equally strong removal of stimulus -- every year from 2011 forward. The Fed was mistaken each time, its models insisting on a new upward spiral which did not materialize. Some things did heal (the taper followed evidence that banks could again generate credit on their own), but no spiral, especially wages not rising with lower and lower unemployment.
Markets are obnoxious. Warn them over and over about a wolf who does not appear, and markets assume there’s no wolf, not just a wolf with a bad clock. The jump in long-term rates and simultaneous pratfall in stocks does not anticipate a faster-higher Fed -- after seven years of false alarms, markets at last understand that this year the Fed is going to do what it said it would. We have every imaginable condition precedent to wage growth and inflation, but not the fact of them, just 90 days’ maybe-could-be signals.
It is so convenient to blame the Fed. Beats hell out of blaming your own salesmanship or your clients. Today’s factoid crowd is as unseemly as the 50-year-old who can’t get over his Mommy’s mistakes.
In 1982 the stock market began a magnificent run from Dow 896(!) coincident with the Volcker Fed’s breaking the back of inflation, and the 20-year cascade of interest rates which followed. Stock market takeoff to outer space coincided with Dow 2,500 in the early 1990s, further coincident with the fall of Soviet Russia and its Iron Curtain, with the opening of China to “capitalism with Chinese characteristics,” and with your first e-mail address and cell phone. By 2000 the Dow quadrupled to 11,000; in 2002 back to 8,000 in the tech bust. By 2007 and the credit bubble, doubled to 14,000. Then in 18 months and the Great Recession, cut in half.
From 7,000 in 2009’s recession-bottom to 18,000 in 2015-2016 made some chart- and common sense, a reasonable gain from the prior top. But, from 18,000 to 26,000 in the 16 months since? Quadruple 2009?
Blame anyone you would like, but... expect to keep that? Keep the hyperbolic curve from triple to quadruple? Fool me once, fool me twice, but the third time... I have only my mirror.
Going forward expect stocks to give up more ground, maybe all the way back to 18,000 for a while, but with little real economic effect, or indication of the real economy. If stocks go that far, then maybe the Fed would pause on the way -- just to watch the somersault -- but wages and inflation are the real deal.
The 10-year T-note two years back. Stalled for now in the 2.80s:
The Fed-sensitive 2-year T-note, taking no prisoners. The Fed’s next hike is fully in today’s 2-year yield, and part of the hike in summer. But not any of the third:
The Dow back to 1990. The marker of folly since fall 2016: the steepening curve of price gains. Note extensive support at 18,000 and none at all above that level:
The Atlanta Fed is not as upside-scary as last week, and not even big growth will necessarily accelerate the Fed: