Yellen Resolved Nothing (and Markets May Have Overreacted)

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"Surprise No. 7: The Federal Reserve Doesn't Raise Rates
I think 2015's Fed rate hike will prove to be a policy error. Despite the consensus of two to three more hikes in 2016 (and the Fed's own forecast of four increases), it's possible the central bank won't raise rates at all in 2016."

-- Doug's Daily Diary, 15 Potential Surprises for 2016 (Dec. 29, 2015)

Stocks celebrated Federal Reserve chair Janet Yellen's dovish comments yesterday afternoon, and the party is continuing in the futures market this morning.

The quarter's approaching end is no doubt contributing to the strength, as is short covering ahead of tomorrow's quarterly close. However:

  • As I suggested months ago in my "2016 Surprise List" above, it seems unlikely to me that there will be any Fed hikes this year (especially given the global economic slowdown). Not only that, rate hikes in coming years appear likely to come more slowly than the Wall Street consensus anticipates.
  • Yellen contended that the Fed has "considerable scope" for stimulus, although I can't see where any potency lies.
  • The central-bank chief said her definition of full unemployment might be lower than previously thought, and that the U.S. inflation outlook is more uncertain.
  • She also continued to expand her definition of the Fed's "data dependency." It now apparently includes the Chinese Purchasing Managers Index, European Union Industrial Production, South American currency rates and, of course, global stock and credit markets' health. (Yellen is said to be a New York baseball fan, so maybe it even includes the New York Yankees' place in Major League Baseball standings!)
  • The Fed chair said that "economic and financial conditions remain less favorable than they did back at the December FOMC meeting." She also frequently used the word "global."
  • Yellen also said "movements in bond yields act to buffer the economy from shocks, serving as an automatic stabilizer."
  • Lastly, she stated that a further drop in oil is bad for the global economy.


Overall, I believe yesterday's speech contradicted recent comments by several Fed regional presidents -- and underscored the central bank's documented poor forecasting skills. The Fed's economic projections (even those of the last two months) have continued to be wide off of the mark when the actual figures later come in.

I think Yellen's remarks also serves as proof-positive that the Fed lives in constant fear of a fall in capital markets and the likely negative-wealth consequences that would entail. (And to me, that fear is certainly justified.)

History Might Provide an Ugly Precedent
However, the last time the Fed moved from tightening to dovishness was back at the end of 2007, and we all know how that ended -- badly.

This time around, I believe that Yellen is attempting to sustain the economy's misallocation of capital but will end up giving us a "gift" of stagflation in the future (perhaps in the not too distant future). As I suggested in my 2016 Surprise List:

"Surprise No. 6: Stagflation
I think stagflation could join 'screwflation' as a concern for 2016. Wages could rise and non-energy commodities (particularly agricultural) could pass the Federal Reserve's inflation target despite disappointing U.S. growth.

Although we could see slowing and recession-like growth in 2016's third and fourth quarters, the yield curve won't invert. But oil and a drought that causes higher agricultural prices could raise headline inflation to well above the Fed's target."

-- Doug's Daily Diary, 15 Potential Surprises for 2016 (Dec. 29, 2015)

In fact, the only thing that surprised me after Yellen's speech was the market's bold and constructive reaction to it.

Saxo Bank Chief Economist Steen Jakobsen captures my thoughts and concerns perfectly. Jakobsen told CNBC yesterday that he believes that the "social contract" between the rulers and the ruled has been broken.

In a recent research note, he wrote that the ratio between U.S. employee compensation and gross domestic product is the lowest in history even as corporate profits are at their highest point ever, according to CNBC. Jakobsen sees this as a key reason why so many voters want anything but the status quo.

He also told CNBC that the antipathy toward how the world's central banks are handling the economy also reflects a break in the social contract.

"We have glorified central bankers in the world today who have behaved like rock stars," the economist said. "Some of them, like [European Central Bank President Mario] Draghi, clearly enjoy being in the limelight. But the effect of what they do, the marginal impact of what they do, is deteriorating -- and massively so."

That's why I wrote yesterday that nothing has been resolved and I remain bearish:

"Federal Reserve chair Janet Yellen led with a dovish chin today -- and Pavlov's dogs started panting all across Wall Street.

But personally, I'm fading the positive response to Yellen's speech, for many of the reasons I mentioned in yesterday's opening missive.

The Jig's Up for Yellen and the Fed as far as I'm concerned, while the widening chasm between stock prices and the real economy represents a fundamental risk factor that the market could be ignoring.

I say we:

-- Let Yellen talk in unintelligible gibberish as she explains the Fed's current failing policy.

-- Let the Federal Reserve and its 100+ economists make their forecasts, which have fallen short for the past four years.

-- Let our leaders in Washington abandon their fiscal responsibilities and ignore structural impediments to domestic growth.

-- Let machines and algorithms buy on the Fed headlines and commentary.

Who cares? Six to seven years of unprecedented monetary easing have failed to translate into escape velocity or self-sustaining growth.

It now appears that real gross domestic product growth won't even average 1.5% for 2015's fourth quarter and 2016's first quarter. Mission Not Accomplished --there is no triumph."

-- Doug's Daily Diary, Sorry, Janet: I'm Still Bearish (March 29, 2016)

I wrote above that the only thing that surprised me after Federal Reserve chair Janet Yellen's speech yesterday was the market's bold and constructive reaction to it.

To this observer, the combination of a bullish stock market and a bearish global economydoesn't add up after seven years of monetary easing that failed to address structural issues.

Besides the elevation of financial asset prices, there's been absolutely no evidence that I've seen over the past two years of the Fed's quantitative easing and 0% interest rates having any direct, positive influence on U.S. economic growth.

The cost of money isn't a material constraint on economic activity, so I don't believe that keeping rates lower for longer will have any important impact. Instead, I think stocks are rising mostly thanks to The Church of What's Happening Now.

Of course, many others feel differently. Just check out today's columns from my Real Money Pro colleagues James "Rev Shark" DePorre and Jim "El Capitan" Cramer. They see Yellen's strategy as a profit panacea and a "green Light" for stocks.

But I see many "peaks" out there -- in stock prices, profit margins, market breadth, housing, autos, commercial real estate, buybacks, M&A, China, Apple (AAPL) and more. And to me, nothing Yellen said yesterday changed any of that.

The bulls are getting the last laugh for now, but it might literally be their last laugh of this cycle. To me, the global economic glass is still half empty and promises not to change in the year ahead -- even in the face of a dovish Fed stance.

 

Doug Kass is president of Seabreeze Partners Management Inc. This essay originally appeared at TheStreet.com.  

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