A trio of speeches from Fed officials indicated a wariness about asset bubbles.
Years of easy-money policies by the Federal Reserve have powered the U.S. stock market. Now, Fed officials say they are watching closely for signs that those policies are prompting risky market wagers.
A series of speeches from Fed officials Tuesday indicated a wariness about asset bubbles and hinted that the Fed may tighten monetary conditions even if key economic signals remain subdued.
As The Wall Street Journal’s Morning MoneyBeat newsletter noted, the notion that central bankers will be quick to support markets to help achieve stable prices and full employment has been validated many times since the financial crisis, but it may lose sway should Fed officials see rising bubble risks.
In remarks prepared for delivery at an International Monetary Fund conference, Federal Reserve Vice Chairman Stanley Fischer pointed to rising stock valuations, thin corporate bond spreads and ultra-low readings on the CBOE Volatility Index as signs of increased risk-taking. While such rising prices have yet to inspire extreme leverage, he said, valuations bear monitoring.
Fed Chairwoman Janet Yellen said in a separate speech that asset valuations were “somewhat rich.” San Francisco Federal Reserve Bank President John Williams told the Australian news media that there are signs of “some, maybe, excess risk-taking in the financial system with very low rates.”
Market behavior has been unusual in 2017 with prices of many assets types moving higher together. The S&P 500 is just below its all-time high hit June 19, while the yield on benchmark 10-year Treasury notes this week plumbed its lowest level since November. Gold is up 8.4% in 2017, slightly more than the S&P 500′s year-to-date return excluding dividends.
Tom Porcelli, chief U.S. economist at RBC Capital Markets, said that the speeches together highlight that the Fed, burned by asset bubbles in the past, will likely be comfortable raising rates if asset prices represent a risk to the economy.
“If the Fed thinks that risk appetite is heading toward unsustainable levels that put financial stability at risk, they are more likely to stay the course on removing accommodation even in the face of softer inflation,” Mr. Porcelli said.
For the first time, the Janet Yellen set into motion firm plans to reduce the size of its $4.5 trillion dollar "balance sheet." Such a process has been talked about for years, but many were convinced, myself included, that it would always just be talk. The balance sheet consists of Treasury and mortgage-backed bonds that the Fed amassed during the experiment with quantitative easing between 2009 and 2014. During that time, the Fed injected liquidity into the financial markets by creating money to purchase more than $80 billion per month (at times) of such securities. These efforts pushed down long term interest rates, drove up bond and real estate prices, and set the stage for a massive stock market rally that had little to do with underlying economic fundamentals. Despite several informal hints over the years that these stockpiles were being reduced through bond maturation, the war chest has not decreased in size by one iota. However, the Fed has admitted that these ponderous holdings will limit its ability to stimulate in the event of future recessions. As a result, it wants to shrink the balance sheet down to a more manageable size now, precisely so it can expand it again during the next recession.
To do this, the Fed must essentially perform quantitative easing in reverse. It must sell, or force the Treasury to sell, treasuries and mortgage-backed securities into the current market. This process will reduce the Fed's balance sheet while drawing free cash out of the economy, thereby unwinding prior stimulus. The Fed even told us how large the reductions will be...and it's a lot. Much in the way that the Fed "tapered" out of its QE program back in 2014, gradually reducing the $85 billion of monthly purchases by about $10 billion per month, the Fed anticipates a similar approach to what is, in effect, a "quantitative tightening" campaign, or QT for short. It will start by allowing it's balance sheet to shrink by $10 billion per month (total) of mortgage and government bonds, and will gradually increase the reductions to $50 billion per month, or $600 billion per year. Those are very big numbers that will provide very real headwinds to the economy and the financial markets.
But it's important to realize that the Fed envisions doing this at a time when Federal deficits are likely to be rising steeply . In the next few years, the Congressional Budget Office estimates that Federal budget gaps will be in at the $700 - $800 billion dollar range annually (hitting $1 trillion by 2021 or 2022). These assumptions of course do not factor in any potential any tax cuts, spending increases, or recessions (I think we are likely to get all three). So this means that in a few years, the Treasury will have to sell $600 billion of additional bonds into the market annually to repay the Fed while at the same time selling $800 billion or more to finance its current deficits. That may create some traffic problems. Should we assume that there are enough buyers to step up to the plate, especially if yields stay as low as they are? It's not likely.
With so much supply hitting the market at once, bond prices will have to fall (and yields rise) in order to attract buyers. This will amplify the tightening effect that these sales are meant to generate. Higher yields will also add a tremendous burden to the U.S. Treasury. With outstanding Federal debt already at $20 trillion, every percentage point rise in rates translates into approximately $200 billion more per year in debt service costs, which also must be borrowed. After the Fed announcement, Mick Mulvaney, the Director of the Office of Management and Budget admitted that quantitative tightening from the Fed had not factored into the Administration's long-term budget projections.
There is much going on before market make a correction, so pay extraordinary attention to your investment and retirement accounts to protect them from the coming crash becoming a Wealth Preserver Member.
DONALD J. TRUMP, PRESIDENT OF THE UNITED STATES, ET AL. No. 16–1436 (16A1190) v. INTERNATIONAL REFUGEE ASSISTANCE PROJECT, ET AL.
582 U. S. ____ (2017) (Per Curiam)
Trump-Internation al Refugee Assistance Project
Donald Trump was vindicated by the Supreme Court regarding the dispute over the provisional entry ban for citizens from six countries. The Supreme Court of the United States overturned the provisional injunctions of subordinate authorities. Of course mainstream media is once again misrepresenting the decision. The New York Times wrote: “On Monday, the justices agreed to review both appellate decisions, but their unsigned opinion did not address the merits of those cases. “
The “unsigned opinion” was Per Curiam meaning it was the UNANIMOUS decision of the entire court and this did not requite an opinion written by one Justice. This is a STAY to allow Trump to do what the travel ban was all about – a review. Such stays are typically Per Curiam when granted for the Supreme Court rarely grants such a stay. Here we have two lower courts interfering with the Executive Powers, for which there was absolutely NO historical precedent. If ISIS openly sent in 1,000 people to be terrorists, they would be able to freely enter all because the lower courts were playing politics rather than law.
Of course there is the famous Korematsu v. United States, 323 U.S. 214 (1944) where the constitutionality of the Presidential Executive Order 9066, which ordered Japanese Americans into internment camps during World War II regardless of citizenship was upheld. There the Supreme Court upheld held that the need to protect against espionage outweighed Fred Korematsu’s individual rights, and the rights of Americans of Japanese descent. So even American born Japanese were locked up just because they were Japanese.
There is even a statue specifying who may not receive a entry visa: 8 U.S. Code § 1182 – Inadmissible aliens. This even bans people with physical disease or mental disorder with the exception of adopting children under the age of 10. Criminals are barred if their crime was involving moral turpitude (sex crime) or a drug dealers. Those convicted otherwise of two or more crimes are banned or women who have been convicted of prostitution within 10 years. Moreover, the Attorney General may ban anyone he reasonably has grounds to believe is seeking to enter the United States to engage solely, principally, or incidentally in the violation of U.S. law.
So why has the media called Trump racist and treated him with such hatred over a 90 day ban? It is just politics. There is absolutely no legal ground whatsoever to deny the order. The Supreme Court noted the exceptions that Trump himself acknowledge needed some qualification. The court provided general guidelines — say, a family member of someone living in the country, a student admitted to a university or a worker with an employment offer in hand.
The Fourth Circuit had struck down the ban using the First Amendment claiming it was religious focused saying Trump’s ban “drips with religious intolerance, animus and discrimination.” That was really a very bad decision since they were bans on six countries not Muslims and that would include even Christians. I have Muslim employees and they come and go with no problem. Clearly, it is not a ban on all Muslims and thus their narrowly focused decision was political, not legally sound. It was a 90 day ban while a review was to be taken. The ban would have been long over by now. In fact, the Supreme Court pointed that out: “We fully expect that the relief we grant today will permit the Executive to conclude its internal work and provide adequate notice to foreign governments” within 90 days, the court said.
The legal grounds for granting a stay by the Supreme Count is straight forward. It must meet a two-prong test (1) whether the stay applicant has made a strong showing that it is likely to succeed on the merits and (2) whether the applicant will be irreparably injured. The mere fact that the Supreme Court issued the stay proves that Trump acted constitutionally and the President has that power.
Had there been only one lower court decision, then the Circuit Justice overseeing that circuit could have issued a stay by himself. In this case, we had two separate decisions from two separate circuits and thus it went to the whole court. That is why the decision a unanimous and thus Per Curiam.
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Livio S. Nespoli has been a broker, registered investment advisor, and financial publisher since 1985.