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Common Cents & Wizardry Among the Fed

Quit trying to orchestrate and manipulate for a change.

My mother is the most pragmatic person I have ever met, or will likely ever meet. She doesn’t suffer fools and is not given to flights of fancy. Perhaps for this reason, she basically just went through the motions with things like the Easter Bunny and the Tooth Fairy. To that end, I don’t remember believing in either of them. Not for a second.

Santa Claus was something of a different matter. I suspect this was because, as illogical as it may be, this ruse makes more sense than other two. This isn’t to say my parents went overboard with the Kris Kringle myth. They didn’t. However, they must have played it out a little longer, because I at least remember wanting to believe in Santa.

Many of my friends, however, were crestfallen when they determined the truth. Santa not real? How could that be? How could my parents have been lying to me all these years? Real tears and all of that, but not at the Norris House.

For long years, the powers that be have led us to believe the wizards at the Federal Reserve (Fed) were the smartest of the bunch. They were the brightest bulbs in the box and the sharpest tools in the shed. While their actions and results didn’t always engender such a reputation, we drank it in regardless. Shoot, we even dubbed Alan Greenspan the “Maestro” due to what we perceived to be his ability to orchestrate economic activity.

We coined phrases like the “Greenspan and Bernanke puts” in the belief the Fed would backstop the markets. We cheered when the Fed bloated its balance sheet to keep interest rates artificially low after the 2008 Financial Crisis. Then, we celebrated again when it did the same thing during the worst of the COVID pandemic.

The wizened Fed, in all of its infinite glory, was the master puppeteer. It could pull whatever strings it needed in order to keep us from the worst of harm’s way. It was the great bandleader, and we simply danced to its music. If we only just believed and hoped hard enough, the Federal Reserve would usher in a great era of robust investment returns and free from recession.

If the events of the last 15 months haven’t been like finding out about Santa Claus, I don’t know what is. Good grief.

This past week, the Fed raised the overnight lending target rate another 0.25% (25 bps) to 5.00%. That is the highest it has been since 2007, but don’t let that coincidence scare you, yet. The reason it has done so is to tamp the inflation it, the Treasury, and local & state governments have thrust on the US economy.

To be sure, the argument is they did so in order to save lives during the worst of the pandemic. They largely shut down the economy to halt the spread of the COVID virus. The Fed added another $4-5 trillion to its balance sheet in order to keep markets functioning properly and interest rates low. Finally, the Treasury spent ridiculous sums of money it didn’t have to keep the economy from cratering, at least at first.

Obviously, hindsight is 20/20. There was no way the combination of all of this wouldn’t be inflationary.

  • Flood the economy with cash?
  • Pump excess liquidity into the financial system?
  • Keep interest rates artificially low?
  • Forcibly shut down demand and then give the consumer free money to spend (somewhat arbitrarily, in my opinion)?
  • Keep on pumping people with cash after the economy is wide open?

Apart from contracting out monetary and fiscal policies with the Zimbabwean Ministry of Finance and Central Bank, I am not sure what else we could have done to stoke inflation. By us, I mean the people who are supposed to be the smartest in the room. After all, isn’t that what the Fed is? Isn’t that what we want our elected officials to be? The maestros? The master puppeteers? The great conductors?

I feel like a kid who came downstairs in time to see their parents put out presents on Christmas morning. Well, perhaps that is a bit hyperbolic.

The maddening part of the recent mess is the markets are effectively screaming for the Fed to stop raising rates. It is almost deafening to those of us in the industry. Still, there are those at the Fed, the idealists and academics, which would counter that the Fed has two primary mandates – price stability and full employment. It isn’t to calm frayed nerves. With prices still elevated and the labor market still tight, there is still room for higher rates.

Or so the bureaucratic thought process goes.

To be sure, perhaps the Fed shouldn’t agonize over vagaries in the stock market. In fact, I might even begrudgingly concede that point. However, the Fed, the Treasury and the other powers that be would be wise to pay attention to the bond market. Right now, it is saying enough is enough. No mas with the rate hikes.

Consider this, as of 1:05 pm CDT on March 24, 2023, the yield to maturity on the 2-Year US Treasury Note has fallen 1.04% (104 bps) this month.

If this holds through the end of the month, it will be the largest 1-month decline in 2-year rates over the last 20-years. The next largest monthly decline was in January 2008, when the yield fell 0.95%.

For its part, the yield on the always important 10-Year Treasury Note has fallen 0.55% over the same time frame. This would be the 4th largest monthly decline in 10-Year yields over the last 20 years. Eerily, the top 2 happened at the end of 2008. Obviously, that is another ominous comparison.

To be sure, markets can be fickle. They can and will fluctuate, and could very well rise between now and the end of the month.

Still, as I type, the relatively steep inversion from the overnight rate to the 30-year suggests one thing: economic activity is going to slow down.

If past is prologue, and I am supposed to say it isn’t even if it usually is, the longer the yield curve stays this inverted, the greater any ensuing slowdown will be. The reason being is simple. When short rates are higher than long rates, it doesn’t make much sense for banks to lend money.

That is what the bond market is telling the Fed.

To be sure, the Fed can turn a blind eye to the markets, and naively say they are of no concern. It can hide behind its so-called dual mandate and inflation target(s), and preach about the independence of the Federal Reserve. Further, it can ride around on its high horse and orate from the largest soapbox in the world. Finally, it can bury its head in the sand and pretend the rest of the world doesn’t matter.

Ideologues are often like that.

However, from this point moving forward, the powers that be run the risk of making a potentially bad situation even worse. This includes the Fed, Congress and governments at every level. My advice to them is: just back off for a while and let everything mend on its own.

Quit trying to orchestrate and manipulate for a change. After all, we are all big boys and girls now.

Interestingly, deep inside, even big boys and girls want to believe in Santa Claus. Perhaps that is the reason why I continue to look into the sky on Christmas Eve with a twinge of hope. Maybe, just maybe, you know? It is fun to think about it.

Laughingly, if Kris Kringle really were real, the following thing would be on my wish list: that the wizards at the Fed really were the smartest of the bunch, the brightest bulbs in the box and the sharpest tools in the shed.

 

Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this any every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.

 

John Norris

John Norris

Chief Economist