I got an interesting comment the other day on one of my columns on Money Morning, and it really points up a recurring misunderstanding that I see about the economy and the markets. So with apologies to Jon, I’m going to use him as a quick object lesson this weekend. (Thanks for commenting, by the way!)
Jon: The author, in my opinion, is off base. Consider that interest rates were manipulated by the Federal Reserve and their counterparts around the world, for what reason? The answer was to stimulate the world economies because at that time we had excess manufacturing capacity worldwide.
To a lesser extent we still have excess capacity but less so than 10 years ago. The Fed has not lost control but it will be tricky to balance the inflationary forces against lessened overcapacity to normalize rates and shrink its balance sheet.
([URGENT] You may be owed underpaid funds revealed by Inspector General Audit…)
Lee: No offense, Jon, but stuff like this – which I see often — is an example of investors completely missing the point. They’re playing baseball, but instead of watching the ball come out of the pitcher’s hand, they’re watching the fielders. It’s hard to get hits when you take your eye off the ball. But your opponent uses deception to get you to do just that.
The economy isn’t the hand that throws the ball. It’s not the cause of market movements. Monetary policy (the pitcher) impacts markets directly and first. The economy is either secondary or tangential. It’s a deke to get you to take your eye off the ball. It’s irrelevant. Liquidity drives stock, and bond prices, and interest rates directly from the central banks to the markets, not via the economy.
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Now, the economy does matter in another sense because the Fed makes policy primarily on the basis of economic data. That’s why, at this stage, strong data, whether on economic activity or CPI, will reinforce the Fed in tightening. If we start seeing weaker numbers, then we can anticipate a policy change. But for now, and for the foreseeable future, the Fed will be pulling money from the system. The decline in the availability of money means that there will be less demand for all kinds of financial assets, including stocks, bonds, and short term money market instruments, including T-bills. More supply and less demand means that rates, the price of money, will rise.
Anticipating policy change really isn’t necessary. Market actors don’t discount the future very well, if at all. The market responds to actual, not anticipated changes in liquidity. We can usually wait for the policy announcement to be sure. The markets can’t sustain a reversal until the money is there. In other words, money talks!
Where we can draw sketchy conclusions about the economy, the data continues to hint that those at the top of the income spectrum are still doing well enough to skew the top line economic numbers positive. That will keep the Fed tight. The economy may do well, but the stock market won’t. Part of the reason will be that rising market interest rates will attract money. Stocks will be sold to raise cash for that purpose.
Massive Treasury supply will put downward pressure on the prices of all financial assets, not just Treasuries. Under QE, the Fed was funding all new Treasury supply. Under QT (Quantitative Tightening) it is actually adding to supply at the same time as it is pulling money out of the banking system. It’s very bearish.
As always, if you’re interested in making profits on the downside of the market, in addition to our ideas here, you can check out Shah Gilani’s put play recommendations in Zenith Trading Circle.
Have a great weekend – and look for a longer Q&A soon.