Twilight Zone For Markets And Monetary Policy

May 22, 2015

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Is it possible for a stock market to trade at all-time highs even as the underlying economy plunges into a deflationary recession with record levels of debt? Until recently I would have said “No Way”. Today, however, it not only seems possible, it seems to be where we might be going.

No wonder investors are more “neutral” and confused than they have been for 26 years.

There is clearly some deep seated unease and most likely it stems from declining confidence in policy despite new highs in stock markets.

Central banks say they have found an incredibly simple formula that they claim is a cure-all policy.  The weaker the economy gets and the lower inflation goes, the more monetary stimulus there needs to be. This monetary stimulus certainly boosts stock markets, but in the US the effect is wearing off and beyond that most people are not experiencing much if any benefit. If it was supposed to work shouldn’t the results be better?

Indeed policy makers keep claiming the economy is doing well enough for interest rates to rise, despite the dramatic collapse in macro economic data over the last 6 months. December 2015 Fed Fund futures contracts are probably the best barometer of what the market thinks about the prospects for a rate rise this year. This contract has rallied from 99.40 at the end of last year to 99.65 today. This directly contradicts the never-ending discussions in the media and by the Federal Reserve about the near term risks of a rate rise.

The Fed says it is “data dependent” but its rhetoric apparently ignores the same data that has created a rally in Fed Fund futures that says there is very little chance of any rate rise this year!

This divergence, or internal inconsistency, has damaged the credibility of policy makers as was well described in Keith McCullough’s tweets this morning.

“Never have so few obfuscated the economic truth to so many.”

Charles Hugh Smith calls this “internally inconsistent accounts of reality” and believes that “this describes the entire financial structure of the U.S.: crazy-making”.

There were many excellent articles and observations this week demonstrating this growing unease. We have now stumbled into a new Twilight Zone for both markets and monetary policy.

This week we were treated to yet another desperate central bank measure, this time from the ECB. They did not like the recent bond market correction in Europe. Guess what the cure is? More QE faster:

The central banks are also resorting to another approach. The incoming economic data is increasingly troubling. One approach is just to spin it in a more positive light, but still it is clear that some of the troubling reality is still coming through. So if they don’t like the data, perhaps it should just be changed:

A more constructive approach would be to reexamine the purpose of monetary policy. If you want to get more deeply into the justification for even any monetary policy at all then the link below provides a brilliant perspective. What you will very quickly find out is that the premise, reasoning, testable evidence, and justification is highly questionable at best:

“There is precious little evidence that monetary policy matters for the major components of demand (investment and consumption look pretty immune to the shifts in interest rates over time).”‘o-the-wisp.pdf?sfvrsn=6

Perhaps there is much more clarity when it is understood that the real reason we have a central bank and monetary policy stems from a directed failure of choice purposefully initiated by JP Morgan and the other banks following the crash of 1907. Just 2 paragraphs in the introduction to this article explain the tragic fork in the road that set us on the current course.

Getting back to the present, it has become crucial to understand that any engagement with the “markets” needs very careful analysis. Both monetary policy and the markets have become so complex, distorted, and compromised that investors need to ask new questions in their process. What still can be achieved given the current fundamental metrics? What if anything do short term returns tell us when markets have become dominated by the overwhelming influence of intervention and popular misguidance?

On the first question David Stockman lays it out the problem very clearly. The fundamentals have become so fragile that the current cycle could peak even with interest rates near zero.

Lastly liquidity is falling as investors are leaving the market in a state of record confusion. This means that “markets” have become increasingly dominated by interventions, and have become more treacherous as a result. I will post the conversation between Nomi Prins and Chris Martenson that goes into some detail on this as soon as it becomes publicly available.

The bottom line in all this is that traders and investors need to exercise higher levels of caution in both the short and intermediate term about what is achievable, and focus more on the longer term. The current predicament could become even more erratic before a more meaningful and hopefully more positive change occurs.

For the time being it is very important to understand that the current situation is what it is, and needs to be addressed, even if it may be far from what we might want it to be.

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