Fed Funds and Instability

If you leave
Don't look back
I'll be running the other way
--OMD

Many things to ponder when viewing this chart.

Fed funds rate has declined from ~18% in 1980 to effectively zero today. A secular decline. The distortions wrought by this policy over the past 30 yrs are mind boggling.

GDP growth has slowed with Fed funds rate decline. This is no spurious correlation.

Not shown here, but lay stock, bond, real estate prices on top of this graph and see what you get. Again, the correlation is not spurious.

The Fed intervenes with easy credit at every 'crisis' point. Can there be more fertile ground for moral hazard?

The secular decline in Fed funds rate indicates that the Fed never fully takes the punch bowl away. Residual stimulus is left in the system after each 'crisis.' There is no 'neutral' funds rate. This is a recipe for addiction.

With Fed funds rate at zero, the Fed has reached the notorious 'zero bound.' Does that mean that they are out of gas? Hardly. There are negative fed funds rates. There is outright asset purchase (a.k.a. 'quantitative easing'). There is straight money printing (e.g., sending people 'stimulus checks').

The tilt to the graph suggests diminishing returns to each unit of Fed intervention. It also suggests that natural market forces are building. At some point that potential energy will turn kinetic--and the Fed will have less counterforce to cope.

Declining Fed funds is a reflection of growing instability.

Path of Addiction

You see the signs
But you can't read
You're running at
A different speed
--Robert Palmer

We have employed the addiction analogy many times on these pages to describe our unbreakable habits of borrowing and spending. The theme surfaced again this week as onlookers described the Fed's inability to cut back ('taper') its stimulative bond buying known as quantitative easing (QE).

Stan Druckenmiller laments the Fed's 'no taper' decision, observing that the central bank could have initiated the process to get us "off the dope." Others, of course, believe that the Fed could not cut back if it wanted to and has effectively trapped itself in a corner.

Parenthetically, Druckenmiller also observes that the Fed's decision not to taper is "fantastic for every rich person" and thinks that this monetary stimulus program amounts to "the biggest redistribution of wealth from the middle class and poor to the rich ever." This is a point these pages have made many times as well.

David Stockman thinks that "we're stumbling into the endgame" as Ben Bernanke hands the baton to (presumably) current Fed vice chair Janet Yellen. Yellen "has no clue how to wean Wall Street from its pathetic addiction to easy money."

The addiction is not just Wall Street's, of course.

There are only two paths for the addict: pull back and kick the habit, or escalate and crash.

Which path is ours?

Blind Addiction

Your lights are on, but you're not home
Your mind is not your own
--Robert Palmer

US public debt recently crossed $14.2 trillion which nearly matches annual GDP. This debt level amounts to nearly $46,000/citizen and over $128,000 per taxpayer.

State and local shortfalls amount to nearly $3 trillion more.

Total US debt exceeds $55 trillion, or more than $676,000 per family. This does not include unfunded entitlement liabilities of at least $30 trillion.

At the federal govt level, we are borrowing nearly $5 billion/day and face daily interest expense of over $500 million/day (expense that will surely rise when the Fed loses control of interest rates).

Federal govt outlays are about $3.5 trillion/yr, which creates a deficit of $1.5 trillion annually.

This is where we are.

And yet there are those who suggest that our current finanical position is not dire.

The Federal government just passed another temporary budget extension that included $6 billion in domestic spending cuts--less than a day's worth of Fed govt spending. Some in Congress are calling these cuts draconian and that no more can be done without crippling government.

Denial and escalation. Traits of the addict.

no positions

Jobs Up, Rate Cut Hopes Down

You like to think that you're immune to the stuff, oh yeah
It's close to the truth to say you can't get enough
--Robert Palmer

A stronger than expected jobs report this am has quickly quelled expectations for a July rate cut from the Fed. The 10 yr is getting hammered, dividend paying stocks are selling off, and gold has dropped nearly 30 handles.

One of the few sectors trading dry is the banks, presumably because rising long bond yields steepen the yield curve for carry trade activities.

Hard not to speculate that market participants won't somehow rationalize that the Fed will still deliver a summer dose of stimulant to satisfy the market's rate cut addiction. Many gold-related instruments are off their lows, perhaps in sympathy to that prospect.

position in gold

QE World

To me
You're like a grown addiction
That I can't deny
--Seal

Here is a graph of major central bank balance sheet assets:

Central bank assets have more than doubled since late 2008, rising from $4 trillion to over $10 trillion. It should be noted that the Fed alone is responsible for nearly $4 trillion of that increase.

As noted previously, the effect on stock markets has been straightforward.

This relationship explains why stock markets rally on bad economic news. They sense additional easy money fix.

position in SPX