In financial markets, like in life, there are always uncertainties. No one knows what tomorrow will bring. All we can do is work hard at our goals, be kind and compassionate, and hope that no one needlessly punches us in the face.
Look back on any period of history and this is obvious. Life is a catalogue of the unexpected. Living with uncertainty is just a part of life. In other words, it’s no big deal. Humans — both individually and as part of a wider society — have been dealing with uncertainty for millennia. We’ve got it covered.
But in the new world of financial repression and central bank micromanagement, uncertainty is a thing to be feared, rather than respected. We cower from making decisions because of ‘uncertainty’, rather than just getting on with it and dealing with the consequences as they unfold.
I bring this up because of US Federal Reserve boss Janet Yellen’s speech last night. It played on this theme of uncertainty to provide cover for not wanting to make a decision. Check this out:
‘In particular, an important theme of my remarks today will be the inevitable uncertainty surrounding the outlook for the economy. Unfortunately, all economic projections are certain to turn out to be inaccurate in some respects, and possibly significantly so. Will the economic situation in Europe or China take a turn for the worse or exceed expectations? Will U.S. productivity growth pick up and allow stronger growth of gross domestic product (GDP) and incomes or instead continue to stagnate? What will happen with the price of oil? The uncertainties are sizable, and progress toward our goals and, by implication, the appropriate stance of monetary policy will depend on how these uncertainties evolve.’
What Yellen fails to realise — or maybe she does but just doesn’t know what to do about it — is that the markets she looks at are also looking at her.
Markets no longer reflect ‘economic fundamentals’. Well, they do, but not in a major way. Markets reflect Fed policy and expectations around Fed policy.
So you’ve got a situation now where the Fed, terrified of uncertainty, watches markets for clues about what to do next, while at the same time the market watches the Fed to get an idea of what it’s going to do next.
Is it any wonder they get it wrong? The whole theoretical framework that the Fed conducts monetary policy with is flawed.
While that should matter on an ethical and intellectual basis, the market doesn’t really care. Markets just deal with what ‘is’. And, as an investor trying to make money, so should you.
That’s why, after hearing Yellen’s handwringing speech about uncertainties (variants of the word mentioned 29 times!), the market surged higher.
Investors realised that the Fed probably won’t raise rates for a long time. Or as Bloomberg puts it:
‘June is out. July might be too soon. The Federal Reserve’s next interest-rate increase is coming, but even September isn’t a sure bet.
‘That’s the message investors and economists are taking from Chair Janet Yellen’s remarks Monday.’
The Dow jumped 0.65%, and the S&P 500 climbed 0.5% on the news. Gold held onto its strong gains, and WTI crude oil jumped more than 2%.
The danger of getting too settled into this ‘no rate rise for now’ scenario is that the Fed maintains that it is ‘data dependent’. So expect the market to swing on important economic data releases. Not because of what the data actually represents, but because of how the Fed might react to it.
More than anything, the focus will continue to be on the employment market in the US. While the situation looks healthy, with the headline unemployment rate at 4.7%, there is still considerable slack in the labour market.
The chart below shows the participation rate in the US, courtesy of The Daily Shot:
[Click to enlarge]
It’s not a pretty picture. It shows a decline in the participation rate, from 66% in 2008 to just over 62.5% now. In other words, if the participation rate was the same as it was prior to the 2008 recession, the headline unemployment rate would be closer to 8%.
Falling labour market participation is a drag on the economy. It reflects the under-utilisation of a nation’s human resources. It means a greater dependence on welfare, and a greater diminution of the magical economic benefit of self-esteem.
It also represents a latent supply of labour that can come back into the market when (or if) wages start to rise, enticing those on the margins to look for work.
So the US labour market doesn’t look anywhere near as strong as you’re led to believe. But don’t make the mistake of thinking that’s because monetary policy is too tight. That’s the central banking mindset.
It’s because money is too easy. Look at the chart above again. Worker disenfranchisement is the result of zero interest rates and quantitative easing. It’s a truth that central bankers will never acknowledge. But it’s obvious to just about everyone else who isn’t seduced by their faulty models and theories.
Australia is headed down the same path. Last month, the RBA cut interest rates, when the case for a cut was less than clear. They meet again today and, after copping a barrage of criticism for last month’s ‘panic cut’, they will sheepishly keep rates on hold.
Will Glenn Stevens obscure his poor decision making by referring to the incredible amount of ‘uncertainty’ in the global economy? It’s a convenient cover, but it just doesn’t cut it.
Coming to the end of his tenure, the market realises that even emperor Glenn is wearing no clothes.
For Markets and Money