We wonder how the central bankers and Wall Street can continue to sound so optimistic about economic growth. After all, the employment report for March was soft and that now brings the first quarter jobs data more in line with the weak 0.5% GDP estimate for the period coming out of the Atlanta Fed. Industrial production data in the U.S. continues to have a recessionary feel to it in stunning contrast to those scalding hot soft data surveys which have become quite useless in terms of helping gain insights on the economy.
While still early in the first quarter reporting season, corporate earnings updates convey little sign of a positive inflection point other than being compared to a very weak year ago period, especially in the energy sector. As a result, we guess that 2017 estimates will be undergoing downward revisions soon. Better come up with a new narrative fast, guys, or those massive ETF inflows may start going the other way.
Including the ECB and BOJ balances with the Fed’s holdings, about $13 trillion of securities now resides at the big three central banks after all the various QE programs. Our Fed has been talking lately about actually allowing its $4.5 trillion balance sheet from the QE years to shrink later this year. Regardless, the flat treasury curve is still stating rather loudly that we are in the midst of a serious monetary policy mistake because it signals slow growth.
It could be just us, but the FOMC seems a lot bolder about tightening now that Mr. Trump is in town. A cynical person might suspect that Yellen and her crew are suddenly less concerned about the constant care and feeding of the equity bubble for reasons that go beyond a clear analysis of incoming data. They even talked about stocks looking pricey according to the minutes of a recent meeting.
Some at the Fed have also mentioned that the U.S. has major fiscal challenges after remaining mostly quiet about that while government debt doubled under the prior administration. We guess a number of them are wondering if they will be hearing “you’re fired” from the Donald as their terms end, so perhaps they see themselves as going out in a blaze of glory like reckless members of the senior class throwing caution to the wind.
We also suspect, as we have written before, that the Fed sees a scapegoat in the White House and recognizes that any problems down the road arising from its hawkish turning will be handled by the media as Trump’s doing. However, in yet another interesting change of opinion since the campaign, suddenly Mr. Trump sees the wisdom of low rates and seems to be warming to Yellen. We are not surprised and have lost track of all of the President’s policy reversals.
Because the reality is that the U.S. economy is not as “growthy” as the pundits portray, we suspect the Fed will be forced to scale back tightening expectations. Even the soft data is coming in a bit weaker now, but that pales in comparison to the collapse in auto sales and the boom in store closures that have now become obvious to someone besides us.
When you start from effectively zero, the first 75 basis points of bumps in Fed Funds are a doozy for the financial system, especially after eight years of making sure the cost of money was ridiculously low. From a global perspective, those that borrowed trillions of dollars outside the U.S. during our years of fringe lunatic monetary policy are enduring a massive margin call.
All of the bickering in Congress and the quick re-establishment of control by the same old K Street crowd on Pennsylvania Avenue makes us think that the swamp forces remain firmly in control. Policy change will be more glacial and less revolutionary relative to wild expectations. That has yet to be factored in by stocks even as bonds, commodities, and currencies show a meaningful reversal of prior optimism.
The healthcare drama is forcing even the most euphoric Trump supporters to face the reality that the market’s ebullient hopes for corporate tax cuts might need to be scaled back dramatically. The sudden fascination with geopolitics and warmongering by a President that ran on a domestic issues agenda is the latest sign that a lot of his campaign promises are falling by the wayside and he thinks it might be best to deflect attention from that.
The bottom line here is that the U.S. has very little room to maneuver fiscally because we have been growing federal debt like mad for years just to maintain a semblance of normalcy and keep crowds with pitchforks away from the Eccles Building. As a result, “huuuge” tax cuts will be quite hard to make happen and that was the big driver of the post-election excitement.
At this point, it is important to keep in mind that equities are the most expensive ever according to the most robust metrics, having been pushed there by two narratives that have driven investor activity, but are now changing for the worse. First, the Fed clearly wants to engage in further policy tightening, even suggesting it will shrink its balance sheet. That would be QE in reverse. Second, the massive move in markets since the election that provided the “cherry on top” for this cycle is looking shakier by the day due to D.C. gridlock. That puts the Trump growth agenda in jeopardy. Further adding to risk is the fact that the overconfident Fed is becoming more aggressively hawkish at one of the slowest stretches of growth in quite some time.