The Fed’s Functions
Since it was established in 1913 to be the Central Bank of the United States, the objectives of the Federal Reserve have changed. Originally, the main job of the Fed was to enhance economic and price stability to lessen severe economic swings. Since then, its mission has been amended over the years, but now the primary functions of the Federal Reserve are fivefold:
- Promoting maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy;
- Enhancing the stability of the financial system.
- Ensuring the safety and soundness of individual financial institutions.
- Assuring the safety of payment and settlement systems.
- Facilitating consumer protection and administration of laws and regulations.
Nowhere do the words “stock market” or “level of stock prices” appear as a stated official purpose of the Federal Reserve. Yet, the level of stock prices is of major concern to the Fed. Perhaps even a pre-occupation. Yes, the stock market is an excellent barometer of the economy, but NOT PERFECT. Markets CAN and WILL BE irrational. No amount of Fed intervention will change human nature.
If the Fed ACHIEVED its 5 stated goals, the need to manage stock prices would be unnecessary. Surely, equity investors would pay a premium to invest in companies in a stable economic environment with moderate interest rates. The Fed’s preoccupation with “listening to” and “placating” the markets may be inconsistent with the other objectives and lead to unintended consequences.
Data Dependent or Stock Dependent?
Following the 2-day Federal Reserve meeting ending Wednesday, investors breathlessly awaited the wording of the announcement for any and all clues as to future policy. They were not disappointed. Sometimes Fed announcements are mysterious but not this time.
The accompanying statement and news conference erased any conceivable doubt about the Fed’s commitment to support securities prices. Chairman Jay Powell repeated his assurance that the Fed would be “patient” and “listen” to the markets. Where in the Fed’s objectives is PATIENCE? (https://www.cnbc.com/2019/01/30/the-fed-gives-the-financial-markets-their-wish-list.html).
In contrast, only a mere 60 days ago, Powell lectured investors that the role of the Fed was NOT to bail out financial losses. Not so, anymore. Powell made it clear that any and all policy tools are “on the table”. Investors naturally took this as a “Green Light” that risk taking is back on.
The 180-degree turnaround in the Fed and Powell is mind boggling. At one time, Powell was concerned about BUBBLES. Now, his words and actions may trigger yet ANOTHER one. Time will tell, of course.
Bond Yields Fall Close to Their Lows
Virtually every market responded with enthusiasm to Powell’s new found supportiveness. Not only did Stocks continue to rally but so did bonds, which is a distinct departure from recent behavior.
The chart on the left illustrates the relationship between the yield on 5-year Treasuries versus the S & P 500.
During the 4th quarter, interest rates fell precipitously on “economic weakness” or slowing. The slowing was indicated in plunging crude oil prices and earnings guidance. Stocks fell as yields fell.
Market behavior beginning with the Post-Christmas “Moon Shot” has been different.
The S & P 500 has rallied for 5 consecutive weeks. If the economy is strengthening, this is not reflected in Treasuries. The Five Year Yield has fallen below 2.45%, barely above its December low yields.
Is this a sign that the economy is NOT strengthening or something else? If this is a sign of falling inflation, someone needs to inform the Precious Metals market.
Gold and Silver are surging higher thanks to the perception of a TOO EASY FED.
Unintended Consequences: Precious Metals
Precious Metals SURGED on the Fed announcement. The Slide show below shows how various markets reacted. Some key takeaways are as follows:
- Gold (GLD), Gold Miners (GDX), and Silver (SLV) are all surging toward key Resistance. Will this time be the charm?
- Copper Miners (COPX) appear to have bottomed. Copper is very economically sensitive with many industrial and residential uses making it a good indicator of economic vitality.
- The Dollar Index is close to breaking down as traders fear depreciation from future Federal Reserve liquidity measures.
Credit Risk Completely Gone?
Bonds of all stripes have soared in response to the new accommodative Federal Reserve. Ten Year Treasury Yields have fallen to just a hair above the lows in yields registered toward the end of last year. As shown below, High Yield Bonds have recouped their entire 4th quarter loss. Investment Grade Corporates have soared to new 52-week highs.
Stocks Rise as Companies “BEAT” (Lowered) Estimates
The chart on the left shows the declining trend in expected S & P 500 earnings which is now declining sequentially. On the right, S & P 500 prices are compared to the trend in earnings estimate revisions.
According to CNBC, through Tuesday, 75% of the S & P 500 reporting companies had “BEAT ESTIMATES”. Apple, which lowered its guidance TWICE, was considered a BEAT, by one penny.
The true story of the earnings season has not been the phony 4th quarter “beats”, but forward guidance. Very, very few companies are guiding higher. Lowering the bar, makes “beating estimates” much easier but meaningless.
The Biggest Casualty: Fed Credibility
For the moment, the markets are beyond thrilled at the Fed’s change of heart. Fed support has either prolonged the Bear Market Rally or possibly killed it altogether. At this point, odds are even as to either outcome.
But, there is a double edged sword. If Chairman Powell and the Fed can be made to change so drastically and quickly, can they be relied on at all? The Federal Reserve is supposed to act independently and beyond politics. What does Chairman Powell and the Fed actually stand for??
The biggest beneficiaries of the loss of Fed Credibility are Gold and Precious Metals. Gold remains the best long-term hedge against a falling dollar. And now, Gold and Silver are close to Long Term Bullish Breakouts.
The financial media is rife with their consensus that all’s clear. They may be right, or they may not. Keep in mind, their motivation is NOT the same as yours. They make money when you’re knee deep in the game. That may or may not be good for you.
At Markonomics101, CREDIBILITY is key. We have NO INCENTIVE to provide you with anything but information you can use to make the best decision for you. Be Informed, Not Misled!
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