I rarely pay attention to the FOMC minutes when they are released, but the subsequent market reaction and noise that has been made about it has forced me to take notice. The takeaway from the minutes was largely that the Fed isn’t going to continue with its easing polices. This quote:
It was noted that the Committee’s forward guidance is conditional on economic developments, and members concurred that the date given in the statement would be subject to revision in response to significant changes in the economic outlook.
is being interpreted as the FOMC saying it will not ease unless economic conditions deteriorate. The market reaction was rather swift, with risk assets selling off almost instantaneously and continuing into todays session. The move confirms that these markets fluctuations are completely dependent on Central Bank liquidity, or lack thereof. The very perception of lack of confirmation of more easy money (note: not a tightening but merely standing pat at all time record levels of easing) was enough to cause a stir. If anything, the fragile nature of capital markets should be highlighted for the observer. My point in writing this is to discuss the schools of thought behind the effects of QE on the capital markets. There is one set of thinkers who believe that QE is analogous to training wheels on a bicycle, and the Fed seemingly signaling that it might remove them is an indication of real growth and real recovery. The other set thinks that the QE and various easing measures are the wheels themselves and that Fed slowing means a slowing of the economy. In other words, the ‘recovery’ is essentially a function of Central Bank easy money and credit. I am a part of that second camp, and therefore the Fed will resume easing further, because conditions will deteriorate as a result of the cessation of further Fed action.
Signs of Growth?
Part of the evidence cited for increased growth and recovery is the recent Personal Income data that was released last Friday. Consensus was pleased with the 0.8% increase in spending, 0.5% adjusted for inflation. The income data was far less impressive, with incomes only rising 0.2% in February, and actually falling in real terms, by the same rate of 0.2%. This suggests that the recent growth in jobs are jobs that are low paying, and ultimately jobs that cannot be responsible for sustaining ‘recovery,’ if you subscribe to the view that recovery is a resumption of the debt financed consumption model that we had prior to 2007. Even more worrying is the fact that the US personal savings rate fell, down to 3.7%. So putting those facts together, we’re seeing decreased income in real terms and increased spending, fueled by a decrease in the savings rate and an increase in credit, including sub prime loan originations. In other words, the ‘recovery’ is really an unsustainable reconstruction of the formula, riddled with imbalances, which led the US off the rails in 2007.
With respect to the Fed, their efforts have led to this situation, and it is only their efforts that can keep it going. So talk of them tightening, or even standing still in the intermediate term is completely laughable. They are going to have to do more eventually if they want to maintain the Debt-Driven-Consumer-Spending model going, because it doesn’t work without them. We learned this lesson last year, and the year before, when the ending of QE2 and QE1 respectively led to rather significant corrections in equity markets, growth projections and employment data. I suspect that the same pattern will play out again, with a soft spring/early summer followed by renewed easing from the Fed. Watch this space.