The US central bank narrative conceals interest rate policy motives, asset bubbles, leverage risks, the debt situation and balance sheet issues. Its self-congratulatory statements are all but informative.
There is something worse in life than being a journalist at a Rolex press conference, where I can tell you from experience that they never answer any of your questions: And that's being a journalist at a press conference of the Federal Reserve.
Here gathers the top echelon of the financial press – yet no one asks any of the relevant questions. The result is a neatly staged Q&A session. Reading the transcript of last week's press conference after the latest rate cut, one can only notice the Fed’s misleading account of the situation, and how circumscribed media questions have become.
The public and some Fed watchers would have markedly different questions to ask. But instead, one journalist asked, with kids gloves: «Wondering if you would categorize the current monetary policy as accommodative (..)?» To which Fed Chairman Jay Powell replies «I think my own sense would be that that's a somewhat accommodative policy.»
A Guinness book moment of euphemism.
To spice it up, some play on words by another journalist: «Can you help me with the appropriate understanding of the word appropriate?»
Fed communication itself is no better. The announcement of its third rate cut last week was stuffed with dream words like «11th year of expansion», «strong household spending», «low inflation», «healthy job markets», «rising incomes» and «solid consumer confidence».
No mention of slowing growth in the third quarter, of slowing private consumption and services, of declining private employment. No mention either of any real estate bubble risk, with housing prices at new record highs. The «strong job market» assessment omits the quality of those jobs, gone from stable income, secure, goods producing jobs, to unstable, lower income, part-time, service jobs.
Let's suppose we accept the Fed’s embellished view: then why cut rates three times in a row? The answer is unconvincing: «to keep the economy strong», «sustain the expansion», «provide insurance». So when the economy is weak, rates are cut, and when the economy is robust, rates are cut, «as long as there are downside risks».
In that case, how did rates ever go up in history, since downside risks were never absent? To be clear: What will become of policy normalization?
Turning now to what really matters: the Fed made no mention of the national debt in the United States, which just broke the $23 trillion mark. Twenty years ago, people worried when it stood at $6 trillion, and in 2014, Donald Trump called it a «real mess» when it reached $20 trillion.
Now that he’s added $3 trillion in less than three years, he’s nowhere to be heard. Nor is the Fed. No journalist asked Powell: «Isn’t that the real reason why interest rates can never go up?» Sky high debt service payments would detonate the debt bomb.
As to markets, the Fed sees no bond bubble, nor excessive risk in the system, even though everyone else sees them and investors in their desperate search for yield have been sliding to ever riskier corporate bonds. «This long expansion is notable for the lack of large financial imbalances», said Powell. Really?
According to Morgan Stanley, a third of investment grade corporate debt should actually be rated high-yield. The «Bond King» Jeffrey Gundlach of DoubleLine has warned that the corporate bond market is a crisis in the making. Louis-Vincent Gave of Gavekal Research calls the bond market the «biggest bubble of our lifetime».
Nor does the Fed worry a second about equity markets, up 400% since their 2009 low. Belying the Fed, Nobel laureate Robert Shiller, like many others, sees «bubbles everywhere»: in the stock, bond and real estate markets. Anyone but the Fed would admit that the secular market boom owes it all to the Fed easing, with almost perfect correlation between rising asset prices and the balance sheet of the Fed.
We also need to challenge the Fed’s magical view that inflation remains very low despite a decade of hyper-accomodative policy. On the contrary, inflation has materialized. But in the form of inflated asset prices, which is where all the side effects of the quantitative easing programs have gone.
Luckily for the Fed, the Consumer Price Index doesn’t reflect this. But instead of raising that point, one helpful journalist suggested to Powell that the definition of «normal» inflation could be lowered. Some reasonable experts in the outside world fortunately consider that QE has led to inflated asset prices and that this should somehow be reflected in an inflation metric.
Which leads us to the new, unnamed «QE4». Chairman Powell discarded it as «purely technical measures to support the effective implementation of monetary policy» and no press member had a word to utter. Unconvincingly, Powell said Treasury Bill purchases and previous quantitative easing programs were very different things, since the latter were aimed at lowering long-term rates, while Treasury Bill purchases «shouldn’t affect longer-term securities».
Facts tell another story: first, whether the Fed buys short term Treasury Bills or long-term Treasury Bonds is the same, as bills can be rolled over forever. Second, yes, the 10-year yield is affected. After it spiked to 1,9% in September when stress hit the overnight repo market, ten-year yields dropped almost instantly, in synch with the Fed action, to 1,5%.
Finally, let’s turn to the Fed’s balance sheet, another omitted topic. After increasing fivefold to $4500 billion since 2008, it shrank to $3800 billion, initiated by Powell's predecessor Janet Yellen. The problem is that shrinking the balance sheet is tantamount to monetary tightening. Central bank selling has led to sharp sell-offs in risk assets. Shrinking the Fed balance sheet is called «quantitative tightening» and the Fed obviously stopped it due to the upward pressure on rates.
So here's the ugly truth: not only can the Fed no longer raise interest rates because of excessive leverage in the system, it can no longer shrink its balance sheet unless it risks crashing the inflated stock and bond markets, as well as the shadow banking system, where a mountain of short-term financing is living on zero rates.
No one cares about a crisis until the very second it hits, but I caution that investors ought to be informed and vigilant. An economy with a $23 trillion public debt, asset bubbles, unable to stop the runaway train of ultra-accommodative policy, calls for caution and a pinch of critical thinking.