FED FUD?

porc · Dec 19, 2014

Moderator Note: This thread was started with off topic posts moved from Short-Term-TSLA-Price-Movements-2014 and the title was created by this mmoderator not by the OP of the first post shown below. Title may be updated if the discussion develops.
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The latest statement of Yellen was quite optimistic, as she believe the US economy is recovering and will be able to handle a normalization of interest rates. That was enough for investors to bid up stock prices, as it supported their narrative that the US recovery is strong and a reality. At the same time the Dollar is rallying against the Euro because everybody believes that Europe will follow the U.S. and do quantitative easing, as it has been such a "success" in the US.

The reality is that Yellen is all but confident that the U.S. economy will be able to handle higher rates. Just look at her purposefully confusing statement:

"Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time"

Yellen knew that the market was expecting the FED to drop the wording "considerable period of time" signaling the upcoming rate rise, everybody is expecting. Because of this broad consensus, Yellens hand was forced, as if she would not have dropped the wording, the markets would have questioned the FEDs confidence in the US economy. At the same time she did NOT want to drop the wording, as she is actually not confident at all, that rate hikes will not cause the US economy to come crashing back to down to earth. So really she wants to as much wiggle room as possible and delay this rate hike. So what she does is drop the formulation in the sense that she replaces it with a different wording, but than immediately goes on to say that patient means the EXACT same thing as considerable period. ABSURD! At this point in time she is just playing games with the market.

The reality is, that the FED is in between a rock and a hard place. On the one hand they have to continue with the narrative that the U.S. is recovering. Thus they have to pretend that interest rates will be normalized. On the other hand they know that the economy cant handle 6% rates.

Either way eventually they will have to introduce QE4: This will mean nominal gains in stock prices like TESLA, crashing dollar, rising commodity prices and eventually interest rate spike to counter out of control inflation.

If the FED actually starts raising rates next year I believe there will be pressure on the stock market. If that happens and the economic data comes in worse than expected they will start QE4 and reverse rate hikes. So I do see a correction before the rescue via QE4 arrives, despite the temporary bullishness because of the FEDS narrative of a US recovery.

Robert.Boston · Dec 19, 2014

Porc, you don't seem to grasp why the Fed used QE and why they won't need to in the foreseeable future. Monetary policy has one primary lever: the fed funds interest rate. For practical reasons, that rate can't go negative. So what is the FOMC to do if interest rates are already at zero but more stimulus is needed? Congress refused to adjust fiscal policy (actually, went backwards, reducing spending), so the Fed created a new lever, QE.

The U.S. economy is recovering fairly well now. QE3 is winding up, and the FOMC sees the opportunity to increase interest rates next year. Not to 6% as you suggest, but nudging up by 0.5% increments to calibrate monetary policy.

This is familiar terrain for the Fed. It's a challenge to thread the needle of finding the right interest rate, but unlike your staggering Eurozone economies, the U.S. seems in pretty good shape for 2015. Putting on my old Fed economist hat, I see a modest nudge in interest rates late in Q2. While this will have a modest downward effect on equities, it's important to remember that the reason the FOMC would increase the fed funds rate is because they saw a strong economy and some potential of over-heating. In that situation, the stock market would also be strong, so the interest rate rise would only be tempering growth, not causing a downward crash.

eepic · Dec 19, 2014

porc said:
Yellen knew that the market was expecting the FED to drop the wording "considerable period of time" signaling the upcoming rate rise, everybody is expecting. Because of this broad consensus, Yellens hand was forced, as if she would not have dropped the wording, the markets would have questioned the FEDs confidence in the US economy. At the same time she did NOT want to drop the wording, as she is actually not confident at all, that rate hikes will not cause the US economy to come crashing back to down to earth. So really she wants to as much wiggle room as possible and delay this rate hike. So what she does is drop the formulation in the sense that she replaces it with a different wording, but than immediately goes on to say that patient means the EXACT same thing as considerable period. ABSURD! At this point in time she is just playing games with the market.

Rest assured the Fed's hand is not forced by market expectations, at best they may factor it into consideration for their policy decisions. Robert.Boston's explanation is an excellent summary of the view and stance of the Fed. Despite the conspiracy theorists, the actions of the central bank have always been consistent with the motivations explained in their releases.

Also the body language of the wording is absolutely relevant. "Patient" communicates a different, albeit subtle, meaning than "considerable time". Case in point, the wording of the Fed changed from "considerable time" to "patient" prior to rate hikes in 2004 Fedâ€™s â€˜Considerable Timeâ€™ Drop Recalls â€™Patientâ€™ 2004 Tightening - Bloomberg

Papafox · Dec 19, 2014

Robert.Boston said:
Porc, you don't seem to grasp why the Fed used QE and why they won't need to in the foreseeable future. Monetary policy has one primary lever: the fed funds interest rate. For practical reasons, that rate can't go negative. So what is the FOMC to do if interest rates are already at zero but more stimulus is needed? Congress refused to adjust fiscal policy (actually, went backwards, reducing spending), so the Fed created a new lever, QE.

The U.S. economy is recovering fairly well now. QE3 is winding up, and the FOMC sees the opportunity to increase interest rates next year. Not to 6% as you suggest, but nudging up by 0.5% increments to calibrate monetary policy.

This is familiar terrain for the Fed. It's a challenge to thread the needle of finding the right interest rate, but unlike your staggering Eurozone economies, the U.S. seems in pretty good shape for 2015. Putting on my old Fed economist hat, I see a modest nudge in interest rates late in Q2. While this will have a modest downward effect on equities, it's important to remember that the reason the FOMC would increase the fed funds rate is because they saw a strong economy and some potential of over-heating. In that situation, the stock market would also be strong, so the interest rate rise would only be tempering growth, not causing a downward crash.

Robert.Boston, Thanks for the excellent summary of how the fed is motivated to respond in the near to middle term.

porc · Dec 19, 2014

Robert.Boston said:
Porc, you don't seem to grasp why the Fed used QE and why they won't need to in the foreseeable future. Monetary policy has one primary lever: the fed funds interest rate. For practical reasons, that rate can't go negative. So what is the FOMC to do if interest rates are already at zero but more stimulus is needed? Congress refused to adjust fiscal policy (actually, went backwards, reducing spending), so the Fed created a new lever, QE.

The U.S. economy is recovering fairly well now. QE3 is winding up, and the FOMC sees the opportunity to increase interest rates next year. Not to 6% as you suggest, but nudging up by 0.5% increments to calibrate monetary policy.

This is familiar terrain for the Fed. It's a challenge to thread the needle of finding the right interest rate, but unlike your staggering Eurozone economies, the U.S. seems in pretty good shape for 2015. Putting on my old Fed economist hat, I see a modest nudge in interest rates late in Q2. While this will have a modest downward effect on equities, it's important to remember that the reason the FOMC would increase the fed funds rate is because they saw a strong economy and some potential of over-heating. In that situation, the stock market would also be strong, so the interest rate rise would only be tempering growth, not causing a downward crash.

The FED cant raise rates without collapsing the economcy, as the whole "recovery" with built on artificial low interest rates. If you take them away the boom turns to bust. Why are the interest rates artificial in my opinion? Because actual consumptions and saving paterns by americans do not reflect a zero rate of interest.

Thus my prediction is: As soon as they start to raise rates the "recovery" turns into a recession and thus they will revert back to lowering rates and restarting QE.

Papafox · Dec 19, 2014

porc said:
The FED cant raise rates without collapsing the economcy, as the whole "recovery" with built on artificial low interest rates. If you take them away the boom turns to bust. Why are the interest rates artificial in my opinion? Because actual consumptions and saving paterns by americans do not reflect a zero rate of interest.

Thus my prediction is: As soon as they start to raise rates the "recovery" turns into a recession and thus they will revert back to lowering rates and restarting QE.

Porc, since you're new to this forum, you probably are not familiar with Robert Boston's credentials in dealing with matters concerning the feds. Maybe someone else will chime in here and say exactly what those credentials are, but they are extraordinary. He couldn't be more qualified to speak on such matters.

green1 · Dec 19, 2014

porc said:
The FED cant raise rates without collapsing the economcy, as the whole "recovery" with built on artificial low interest rates. If you take them away the boom turns to bust. Why are the interest rates artificial in my opinion? Because actual consumptions and saving paterns by americans do not reflect a zero rate of interest.

Thus my prediction is: As soon as they start to raise rates the "recovery" turns into a recession and thus they will revert back to lowering rates and restarting QE.

I think there may be some misunderstanding here, interest rates aren't either "high" or "low" they're a continuously variable number. As such, a rate increase can be done that is small enough to not force any significant amount of people to default on all their loans, while still nudging the economy in the direction they want it to go. If they jumped the rate to 5, 10, or 15% you'd be right, the economy would come tumbling down on it's ear, but a 0.5% change is pretty small in the scheme of things.

Auzie · Dec 19, 2014

porc said:
The FED cant raise rates without collapsing the economcy, as the whole "recovery" with built on artificial low interest rates. If you take them away the boom turns to bust. Why are the interest rates artificial in my opinion? Because actual consumptions and saving paterns by americans do not reflect a zero rate of interest.

Thus my prediction is: As soon as they start to raise rates the "recovery" turns into a recession and thus they will revert back to lowering rates and restarting QE.

Your premise "recovery is built on artificial low interest rates" is simply not true. Low rates are one of the tools used to stimulate the economy when such stimulation is needed.

US recovery is built on increasing business activity, businesses are selling their services and products at increasing rate. That is evident in various economic indicators, one of which is increasing GDP.

I wish "building recovery on artificial low rates" was a possibility. If that was so simple, we would have economic boom in the whole world as every government would just lower their rates and voila - we have a boom!:wink:

By the way, I am so curious about that "natural" rate. The existence of the natural rate is implied by the term "artificial".

Low rates are just a small tool, one of the many. Fundamentals are in human capital embedded in robust infrastructure that incorporates supportive regulatory environment, independent justice system, and I could go on and on, listing all possible attributes that make society civilised.

porc · Dec 19, 2014

Auzie said:
Your premise "recovery is built on artificial low interest rates" is simply not true. Low rates are one of the tools used to stimulate the economy when such stimulation is needed.

US recovery is built on increasing business activity, businesses are selling their services and products at increasing rate. That is evident in various economic indicators, one of which is increasing GDP.

I wish "building recovery on artificial low rates" was a possibility. If that was so simple, we would have economic boom in the whole world as every government would just lower their rates and voila - we have a boom!:wink:

By the way, I am so curious about that "natural" rate. The existence of the natural rate is implied by the term "artificial".

Low rates are just a small tool, one of the many. Fundamentals are in human capital embedded in robust infrastructure that incorporates supportive regulatory environment, independent justice system, and I could go on and on, listing all possible attributes that make society civilised.

I think you misunderstood me. Building a recovery on artificially low interest rates is not possible. Thats why I put the term recovery in quotes. Its not a recovery but an unsustainable boom that must be followed by a correction or bust. The boom is caused by artificially lowering interest rates. The natural rate of interest is the rate of interest that would exist without central bank intervention, without the expansion of credit through money printing. The natural rate of interest is an expression of time preference: I.E. how much would you need to be given in the future to be persuaded to reduce consumption now. A zero rate of interest implies a high savings rate and low consumption, i.e. the public releases resources into the economy that can be used for the build up of capital goods.

If you lower the interest rate without the actual consumption and saving preferences having changed, a boom will result that will turn into a bust as soon as the public restablishes the old consumption and saving habits. Entrepreneurs make decisions based on false signals (artificial low interest rate) which leads to malinvestments, that will have to be liquidated in the bust.

dm28997 · Dec 20, 2014

I am very impressed with the information here. Great rebuttals. I wonder what the EU's prospects are for 2015. I have invested mostly in the US now holding only one company in the EU which is Vivendi due to its nice dividend. Anyone have an opinion, with the Russian bear rattling the cage,:cursing: that some investments might be considered.

Auzie · Dec 20, 2014

porc said:
I think you misunderstood me. Building a recovery on artificially low interest rates is not possible. Thats why I put the term recovery in quotes. Its not a recovery but an unsustainable boom that must be followed by a correction or bust. The boom is caused by artificially lowering interest rates. The natural rate of interest is the rate of interest that would exist without central bank intervention, without the expansion of credit through money printing. The natural rate of interest is an expression of time preference: I.E. how much would you need to be given in the future to be persuaded to reduce consumption now. A zero rate of interest implies a high savings rate and low consumption, i.e. the public releases resources into the economy that can be used for the build up of capital goods.

If you lower the interest rate without the actual consumption and saving preferences having changed, a boom will result that will turn into a bust as soon as the public restablishes the old consumption and saving habits. Entrepreneurs make decisions based on false signals (artificial low interest rate) which leads to malinvestments, that will have to be liquidated in the bust.

My counter argument is that US recovery is due to increasing economic activity as measured and reflected in growing GDP. GDP graph is undeniably factual.

Central bank sets cash rates by selling and buying money on the money market. If we call such rate artificial, then the whole purpose of the Central Bank is 'artificial' by the same logic. It is not possible to have natural rates in countries that have a central bank. I am not aware of the existence of such countries nor would I dare to participate in their markets.

MSMike said:
I am very impressed with the information here. Great rebuttals. I wonder what the EU's prospects are for 2015. I have invested mostly in the US now holding only one company in the EU which is Vivendi due to its nice dividend. Anyone have an opinion, with the Russian bear rattling the cage,:cursing: that some investments might be considered.

I am in the same boat with you regarding investments, I shifted to US markets in 2013, for few reasons:
a) my expectation for currency movements AUD.USD. Currency move made me close to 25% gains so far.
b) I stumbled onto TSLA .
c) Us market is by far the most efficient (information flow) in the world.
d) US recovery seems to be ahead of the rest of the world, hence the biggest upside in US-based businesses.

It is interesting that Swiss Central Bank imposes negative interest rate, to tamper local currency appreciation.

My view of investment in EU zone is that such investments would carry far more risk and less upside than investment in US-based businesses, for many reasons.

These risks in Europe are structural or fundamental problems, very difficult to manage and overcome.

Some of the risks - EU lacks unified national, cultural identity and language, there are too many political unresolved tensions between members, as reflected by Ukraine. The sanctions imposed on Russia are hurting the whole of Europe, more or less.

I think it was a mistake to have a single currency across diverse members, without unifying political, financial and regulatory structure to support single currency. With single currency, ECB is needlessly restricted in what they can do to help stimulate recovery.

I assume if you buy into a business listed on say Frankfurt market you must simultaneously enter into EU.USD transaction. Perhaps currency transactions could be avoided if EU business is listed on US markets and can be traded there.

porc · Dec 20, 2014

Auzie said:
My counter argument is that US recovery is due to increasing economic activity as measured and reflected in growing GDP. GDP graph is undeniably factual.

Central bank sets cash rates by selling and buying bonds on the open market, so they are just one of the many market participants. The rate that emerges from their bond buying/selling activity is set in the open market. If we call such rate artificial, then the whole purpose of the Central Bank is 'artificial' by the same logic. It is not possible to have natural rates in countries that have a central bank. I am not aware of the existence of such countries nor would I dare to participate in their markets.

You cant mistake central bank credit expansion with legitimate free market setting of interest rates. If you set interest rates via credit expansion, you are price fixing. Price fixing as you know does not work.

Lowering interest rates artificially, sends the signal that the public has increased savings and reduced consumption, even though this has actually not occurred. Lots of projects suddenly seem profitable, that werent before. In reality however, they still arent profitable and cant be followed through to completion, as the real savings do not exist to support them. To many investments are started in relation to actual resources that are available. Thus a boom is started that ends once the realisation sets in, that not all projects can be completed, as the consumption saving pattern of the public does not support them. Its a misdirection of resources and malinvestment due to false signals.

If the central bank expands credit no resources are released into the economy. If people save, they release resources that can be used for investment. Its vital to understand this distinction.

Therefore the recovery is built on quick sand.

Regarding your GDP argument: Look at the debt. The US government has increased debt several fold over the last years. Of course you will get some increse in GDP if you take on more debt.

Secondly, the GDP has to deflated by a realistic inflation rate, which in my opinion is not happening.

NigelM · Dec 21, 2014

porc, have you been reading the-dark-side-of-artificially-low-interest-rates? ;-)

porc · Dec 21, 2014

NigelM said:
porc, have you been reading the-dark-side-of-artificially-low-interest-rates? ;-)

No, but he seems to be a follower of Austrian economics as well.

Regarding the Russian market: Anything that falls as much as the Russian market should be considered for investment. You get as much as 15% dividend yields, PEs that are below 5.

I am not invested but would consider it I was still looking for investment ideas.

Of course one has to pick the stocks wisely.

NigelM · Dec 21, 2014

porc said:
I am not invested but would consider it I was still looking for investment ideas.

I'm curious, you're pretty down on Tesla, you're pretty down on the U.S. economy, not interested in Ruusia etc., where are you invested or are you focussing on shorting and/or betting against certain markets?

porc · Dec 21, 2014

NigelM said:
I'm curious, you're pretty down on Tesla, you're pretty down on the U.S. economy, not interested in Ruusia etc., where are you invested or are you focussing on shorting and/or betting against certain markets?

I am not shorting any markets. Especially shorting the US market is dangerous, as a falling dollar will make stock prices rise nominally. Priced in gold however, the U.S market has been in a bear market since 2000. I expect this to continue.

1) I am bullish on gold/ silver stocks, even though I believe the correction in gold could go as low as 1000 dollars per ounce. That would be a 50% correction from its highs, which would be a similar correction to the 1970s, where gold collapsed from 200 to 100 dollars only to rally up to 800. The gold market overheated in 2011, when lots of mystiques and conspirary theorists and their moms were invested. It basically had been up every years since 2000 (rallying from 250 dollars to over 1900 dollars). Now the mood is much more gloomy in this sector, which I love, but it might have to go even lower before it can rally again and complete its bull market. However prices of gold silver stocks are already attractive now. One just has to be prepared for a further correction that lasts up to 1.5 years. The turning point will be when the FED announces QE4. What could happen is that the FED increases rates, and then is forced to make a 180 degree turn and announce further stimulus. These events could take anouther year or 1.5 years to play out. But as soon as further stimulus is announced gold and silver stocks will explode to the upside.

2) Even though I am not invested, the Russian market is interesting. A severe correction, historic lows, attractive dividend yields and low PEs.

3) I think Teslas stock is overpriced, when looking at the risk reward profile. As far as I can judge the situation, significant technological hurdles remain (range, charging times, cost of batteries) and the market has already discounted great execution (at least until 2020). Also enormous capital expenditures might mean further dilution. Because as of now, they are not making any profits and are eating up their cash reserves. If they want to expand rapidly further dilution is almost unavoidable.

4) If I had to choose between investing in Asian and US/ Europe markets, I would prefer to invest in Asia. The reason being that they have high saving rates, a trade surplus and that they are freeing up their economy, while the U.S. and Europe are increasing governement intervention. Historically speaking the US market is overpriced (PE ratios, dividend yields). That doesnt mean that the US market cant rise nominally however.

5) Historic low interest rates I believe will mean that after the stimulus experiment has failed (runaway inflation after QE4 etc.), they will have to aggressively raise interest rates. Thus US-bonds are a bubble that will pop. US Treasuries are probably the worst investment on the planet right now.

SW2Fiddler · Dec 21, 2014

Auzie said:
By the way, I am so curious about that "natural" rate. The existence of the natural rate is implied by the term "artificial".

Best written paragraph I have read all week! At least for me, it was more persuasive than all the other words in this thread combined.

porc · Dec 21, 2014

SW2Fiddler said:
Best written paragraph I have read all week! At least for me, it was more persuasive than all the other words in this thread combined.

I dont see whats so persuasive about that paragraph. Would you ask the same question, when somebody accuses the government of price fixing butter? Would you ask what is meant with when somebody then says: The price for butter is artificially low or high? Of course not.

The same goes with interest rates. You cant set interest rates. The market has to decide.

You cant lower rates by printing money. If savings can be created by printing money, then wealth could come from the printing presses. Think about it.

I guess you follow the Keynsian theory, if you are so convinced that the Central Banks should set rates and that there are no artificial rates and credit expansions.

Johan · Dec 21, 2014

If there was such a thing as a natural interest rate (a sort of concequence of pure market forces) that was higher than the "artificial" rate set by the FED, wouldn't the "natural" rate rule? I mean the central bank's rate is not forced on to banks for example. If it was possible to lend out money at 8% I'm sure the banks would, right?

Auzie · Dec 21, 2014

Johan said:
If there was such a thing as a natural interest rate (a sort of concequence of pure market forces) that was higher than the "artificial" rate set by the FED, wouldn't the "natural" rate rule? I mean the central bank's rate is not forced on to banks for example. If it was possible to lend out money at 8% I'm sure the banks would, right?

In the case of US, the implication is that by increasing the money supply (QE) the rate is pushed too low.

What is the bar or benchmark that says that the rate is too low or too high? Imo that would be various national economic indicators.

There is a risk of devaluing the currency with too much money supply. It seems to me that in this particular case US FED played its hand quite well. USD is strengthening despite the increased supply.

There are risks, situation can change, it always does. Imo we still have a bull market ahead.

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