Another Reason Why the Fed’s Plan is Doomed?

Unsurprisingly, the S&P500 inched up another 1.5% last week.  Although volume rose, it was options expiration week and volume tends to rise–regardless of price direction–during these weeks.  The VIX (or fear) index inched up however, signalling that the markets may not be completely comfortable with the increase in price.

The economic data were fairly weak, as usual.  The Treasury’s budget deficit was $91 billion in August; what’s surprising is that the federal debt rose by $212 billion in August.  Could the Treasury be understating the monthly deficit?  Retail sales rose slightly more than expected in August; but much of the extra gain came from the reinstatement of one-time tax holidays in several states.  Business inventories rose more than expected, and the problem with this is that the sales to inventory ratio is falling, so this could lead to serious production cutbacks unless sales pick up soon.  The Empire State manufacturing survey was worse than expected.  Producer and Consumer prices all rose fairly in line with expectations.  The Philadelphia Fed survey was much worse than predicted; and the leading components in this survey were very bearish.  Finally, consumer sentiment fell, when it was expected to rise; ominously, this was the lowest sentiment reading since August 2009.

Technically, the S&P is still showing a bearish formation.  The 50 day moving average is still below the 200 day.  A long-term head and shoulders topping formation is still in effect.  And several market breadth indicators are pointing to strongly overbought conditions,  conditions that often lead to a pullback in the near term.

The Economist this week, in its Buttonwood column, identified another serious, but unforseen, pitfall that the Fed’s monetary stimulus policy is likely to suffer from.  Since the Fed has slashed its short-term rates to near zero, and pumped in over $1.5 trillion into the Treasury and mortgage markets, it has caused all interest rates–short-term, medium and long-term–to collapse over the last couple of years. 

The goal was to stimulate spending by consumers and investment by businesses.

Well, all is not going according to plan.  Instead of spending money that became cheaper to borrow, consumers began to reduce borrowing–despite to cheap cost of credit.  And businesses, as they refinanced their older costlier loans, began to hoard the added cash, instead of investing it in new plants or equipment.

The main reason consumers said no to more borrowing and spending was that they were already up to their eyeballs in debt.  By any traditional measure, such as household debt to GDP, or debt to income, consumers were over-leveraged and thus less inclined to borrow more.  Low cost was no longer enough to make them borrow more.

But what The Economist highlighted was an additional burden on consumers.  Many are beginning to fear that the ultra-low rates are here to stay.  So if consumers will earn less than half of what they were conditioned to expect to earn from their fixed income investments in retirement, then they would need to SAVE considerably MORE than they originally had planned to save. 

The result?  Consumers are pulling even more cash away from spending, thereby depressing spending and economic growth.  And at the institutional level, pension funds and other retirement schemes will also be forced to demand more contributions from future retirees or public and private employers.  In either case, there will be less cash available to spend in the economy.

So perversely, the Fed’s “stimulus” policy, namely driving down interest rates, may ultimately serve to do the exact opposite:  throw a heavy anchor on the economy and suppress the prospects of recovery.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: