If you're anything like us, all the pronouncements that the Federal Reserve makes, as well as those that are made about the “Fed” seem more than a little convoluted. Obscure. Unclear. Take your pick!
So in a few paragraphs, this week’s Update attempts to make clear what we think the Fed is up to at present, and takes a run at postulating the result.
You might just enjoy the explanation and who knows, maybe the next time Janet Yellen speaks it will be more understandable!
All the best,
Lee and Jeremy
PS—We’re getting very excited about our OPENING NIGHT MOVIE PREMIER—“When The Game Stands Tall” starring Jim Caviezel, one of Hollywood’s hottest actors. It’s on August 22nd at 7 p.m. And is great for kids of all ages. We hope to see you there, and if you haven’t done so, please RSVP today (it’s 100% on us)!
This Week’s Quote:
“While admirers of capitalism, we also to a certain extent believe it has limitations that require government intervention in markets to make them work.”
― Janet Yellen, Fed Chair
JL Davis Thoughts This Week:
Whether one agrees or disagrees with Mrs. Yellen’s quote this week, it doesn’t change the results. The Federal Reserve appears to have a desire to actively intervene in the capital markets of United States in a manner unprecedented throughout history. And they’re doing a very effective job of it.
Prior to the bond buying spree of the last few years, the Fed’s normal balance sheet was approximately $800 billion. Today, it has ballooned to over $4 trillion. Not only that, but Fed control over banks and other financial institutions post 2008 is a virtual stranglehold, for better or worse, due to a plethora of regulation.
In recent years, the Federal Reserve has moved from occasionally intervening in financial markets to a monolithic institution that has enormous impact on the entire financial system the U.S. The most recent pronouncements from Federal Reserve Board Chair, Janet Yellen, and others on the Federal Reserve Board involve what they term “macroprudential regulation”… ongoing economic intervention.
Though defining “macroprudential regulation” remains unclear, it appears to mean managing “bubbles”--systemic risks-- in such a way as to attempt to avoid catastrophic economic problems. A noble goal. The Fed’s theory seems to be that regulating particular behaviors can reduce the risks of financial instability in the economy. However, this has never been successful in history as far as we know.
The Fed’s stated purpose in terms of policy is to keep unemployment low and inflation in check. Again, noble goals.
But, not so fast. If rates are held artificially low, some investors may well to leverage up more than they would otherwise. All of us remember easy money and the bursting of the housing bubble just a few years ago. But if “macroprudential regulation” was policy at that point, the Fed might well have moved to regulate home lending activity directly. They might raise the capital required by banks to make home loans. They might limit certain kinds of lending. In short, intervene in normal markets. Put another way, eliminate the normal function of a free financial market. With uncertain results.
Sir Isaac Newton postulated that for every action, there is an equal and opposite reaction. So, it remains to be seen what the results of all this will be. But it’s a fair guess that even more power will be concentrated in the hands of the Fed – for better or worse. It’s gone a long way already.
From 1977 and 2007, the balance sheet of the Federal Reserve (the monetary base) averaged 5.4% of US GDP. Today, it’s 22.4%. Only during World War II was any government institution, in that case the military, ever been so large. And it appears to be growing from there.
Congress will be debating these issues and of course, upcoming elections will have an impact. But for now, the course appears set. How we respond is how we always do.**
With caution
Lee and Jeremy
http://www.federalreserve.gov/newsevents/speech/tarullo20130920a.htm
Market Week: August 11, 2014
The Markets
Investor indecision about the future of equities prices, coupled with light summer trading volumes, led to volatility across the board last week. Friday's 186-point rally gave the Dow some relief after two down weeks, though not enough to nudge the index into positive territory for the year. The small caps of the Russell 2000 had their strongest week since early July, though they also remained down year-to-date. Meanwhile, geopolitical tensions increased demand for the relative security of the benchmark 10-year Treasury bond, sending its yield down. However, riskier high-yield bonds saw some selling pressure.
Last Week's Headlines
• Growth in the U.S. services sector accelerated in July. The Institute for Supply Management's gauge of activity in service industries rose 2.7% to 58.7%--its highest level since the index was launched in 2008.
• New orders at U.S. manufacturers were up 1.1% in June. The Commerce Department said the gain boosted factory orders to their highest level since record-keeping began in 1992 and that June was the fourth month of the last five to see an increase.
• A drop in oil imports helped cut the U.S. trade deficit by 7% in June, according to the Commerce Department. U.S. exports rose 0.1% to their highest level on record, while imports dropped 1.2%.
• Italy's economy fell back into recession, falling 0.2% in Q2; it was the second consecutive quarterly contraction. The GDP of the eurozone's third largest economy also was down 0.3% from the same quarter a year earlier.
• In retaliation for new European Union and U.S. economic sanctions, Russia imposed a one-year ban on a variety of food imports and said it's considering prohibiting EU and U.S. flights from Russian airspace over Siberia.
• As expected, the European Central Bank left key interest rates unchanged. President Mario Draghi said measures already adopted are having an effect and that it was too early to assess the potential impact of Russia's ban on European food imports.
• Eleven of the largest U.S. banks must rewrite their proposed plans for handling a potential bankruptcy. The Federal Reserve and Federal Deposit Insurance Corp. said the plans contained "no credible or clear path" to achieve an orderly failure and avert any need for the type of bailouts provided during the 2008 financial crisis. The banks have until July 2015 to submit revised so-called "living wills."
• Fair Isaac Corp. said it will change the way it calculates credit scores, underweighting unpaid medical bills and excluding overdue bills that are subsequently paid or settled with a collection agency. The changes could make it easier to get credit.
Eye on the Week Ahead
With the Q2 earnings season winding down, retail sales and wholesale inflation data will vie with global conflicts for investor attention. Speeches by two members of the Fed's monetary policy committee are likely to review the arguments for and against accelerating an interest rate hike. Finally, options expiration at week's end plus trading volumes that are likely to remain relatively low could mean additional volatility.
Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance: Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results.
The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indices listed are unmanaged and are not available for direct investment.
Page 3 of 3; Prepared by Lee Davis** and Broadridge Investor Communication Solutions, Inc. Copyright 2014
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