Outside the Box

Taper Capers

October 1, 2013

Michael Lewitt has long been one of my favorite thinkers and writers on matters economic. He's incisive, thorough, and, well, pithy. No holds barred. Today's Outside the Box features an extended excerpt from the October issue of Michael's The Credit Strategist, which he has kindly allowed me to pass on to you.

Michael leads off this month with some useful thoughts on "the art of learning to live with intellectual and emotional discomfort," which he says is a key requirement for successful investing. Then he extends these thoughts in order to give us a critique of recent Federal Reserve behavior that is different from any I've seen. The FOMC (Federal Reserve Open Market Committee), he says, has been seized by intellectual rigidity:

The fact that central bankers are agonizing over whether to begin reducing bond monthly purchases by $10-15 billion within the context of a $3.5 trillion balance sheet suggests that they have lost the forest for the trees….

The FOMC now seems to consider quantitative easing as virtually a status quo policy tool.  No doubt employment growth and inflation are not where the central bank would like them to be, but monetary policy is not going to solve those problems – and economists of sufficient stature to serve as governors of the Federal Reserve are supposed to know that.

Michael goes on to examine the FOMC's continued focus on employment and housing:

Some now think that the FOMC won’t be satisfied until U6 (the unemployment measure that includes discouraged and underemployed workers) drops below 13%. Recent comments from Mr. Bernanke started to back off from the 6.5% target and it is clear that the FOMC is trying to slip out of its own noose.) That is why the FOMC stressed what it termed a tightening in financial conditions in its statement.  The one area of the economy that has undeniably seen deterioration is housing and there is little doubt that the 100 basis point increase in mortgage rates since June is the primary reason.  The committee appears to have placed enormous weight on this factor in deciding not to taper in September.

Aside from housing, though, Michael doesn't see any meaningful tightening in financial conditions, and so "it is difficult to reconcile the Federal Reserve’s dire view with what is actually happening in the financial markets."

You will only see about half of The Credit Strategist here today. There were also sections on the Middle East, JC Penney, bond-market liquidity, currencies, and stock and credit investment recommendations. You can subscribe to The Credit Strategist by going to www.thecreditstrategist.com.

In a note he sent me over the weekend, Ben Hunt lends weight to the notion that the Fed is intellectually (and, I would say, politically) frozen. I include that here as a follow-up to Michael's analysis:

If the Fed believes "a fairly typical cyclical recovery" requires all-out, pedal-to-the-metal QE, under what economic conditions would QE ever be wound down? What level of QE would be required the next time we experience a fairly typical cyclical recession? I mean … it's not like political risks and growth uncertainty are ever going to just magically disappear. It's not like the business cycle has been eradicated.

As regular readers of our Over My Shoulder service know, I have become a big fan of Ben Hunt's Epsilon Theory, and I featured Ben's "Uttin' On the Itz" piece last week in Outside the Box.

I write this note from Chicago, where I am in town for a series of presentations for my partners at Altegris. This morning I decided to trade my usual treadmill time for a longish walk on the lake front. The temperature was a pleasant and the view scenic, removed from the turmoil that is Illinois and Chicago, but the sky was overcast and the atmosphere somewhat gloomy. Which seemed appropriate after I what I had written about their pension and budget woes. I note, too, that city buses are adorned with ads for Indiana, trying to get businesses to relocate there to lower their taxes and overhead costs. I stayed at an historic old hotel, the Millennium Knickerbocker, which, like a metaphor for Chicago, has some great parts but is coming apart at the edges. Service is spotty, although I could get a cup of coffee at 6:30 in the morning as long as I was willing to walk around the corner to the Hilton.

At the desk as I checked in was a sign that said valet parking was $83 a night (not a typo!). When queried, they defended their pricing as cheap because other hotels in the area charged over $100. I was picked up for my early morning meeting with a full room of Merrill brokers. We parked the car for 90 minutes, and it set me back $33. Good thing inflation is so low in Chicago. On a bright note, I found a marvelous new pan-Asian restaurant called Jellyfish on Rush Street. If it was in Dallas it would be my new favorite place. Fresh-faced staff, management with a drive to please, and really good – no make that great – food. Chicago will not go away, of course, but doing business here is going to be a challenge.

I get asked what I think about the current shutdown of government, and privately, I admit I hate to think about it, which I suspect is how most of you feel. The real issue will be the debt ceiling. We will get through this, of course, but it is sad and difficult to watch – not just the budget issues, but the whole foreign policy show, the scandals, the NSA issues, not to mention the Fed feeling like they have to micro-manage an economy that can’t be taken off the training wheels. It makes me wonder whether Chicago is not an even larger metaphor. I truly hope not. The federal government has so got to change. Actually, it will change; the question is how.

Your wondering what the catalyst will be analyst,

John Mauldin, Editor
Outside the Box

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Taper Capers

Excerpted from the October, 2013 edition of The Credit Strategist, by Michael Lewitt

A foolish inconsistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines.  With consistency a great soul has simply nothing to do.  He may as well concern himself with his shadow on the wall.  Speak what you think now in hard words and to-morrow speak what to-morrow thinks in hard words…

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Oct. 2, 2013, 2:53 p.m.

I wouldn’t be surprised if many years from now it is revealed the Obama administration had influence on the decision not to taper.

Tim French

Oct. 2, 2013, 5:11 a.m.

The correct quote (from Emerson’s essay, “Self Reliance”) is: “A foolish consistency…” Not, as this article has it, “A foolish inconsistency…”

Bruce Lawrence

Oct. 1, 2013, 10:06 p.m.

Translating Fedspeak To Plain English

Every pundit and commentator in the known universe has now spoken at length on the meaning and strategy, and pitfalls of the FOMC’s non-taper decision. Much of the commentary is insightful and interesting reading full of complex reasoning about complicated economic theories.
But after all of that what should one do? One of the oldest truisms on Wall Street is “Don’t fight the Fed.” 
The Fed’s greatest fear is deflation.  The leadership of the Fed believes it has the tools to defuse inflation and they will not be too bothered by inflation unless it rises above the 2 to 3% annual rate. But these same economics wizards have relatively few weapons against outright deflation.  The Fed’s preferred inflation measure is the so called core PCE statistic published with quarterly GDP estimates.
Matthew Boesler of Business Insider explains the most recent reading:
The Fed’s Favorite Measure Of Inflation Plunges Further

Read more: http://www.businessinsider.com/core-pce-plunges-in-q2-2013-9#ixzz2gVh3IeNv
Core personal consumption expenditures, an inflation indicator reported in the U.S. GDP release, stood at only 0.6% in the second quarter, according to the third and final Q2 GDP reading published by the U.S. Bureau of Economic Analysis this morning.

Core PCE of 0.6% marks a sharp drop in inflation from the first quarter, when core PCE stood at 1.4%.  from Business insider
The drop from 1.4% rate in 1st qtr to 0.6 in the 2nd qtr is substantial and ominous though it is only one reading. Until that one statistic rebounds there is no chance of any meaningful taper. The Fed is saying decisions about a taper are data dependent and they are telling the truth. Until core PCE is rising and much closer to 2% they will not act to tighten unless forced by some type of market panic.

Shawn Allen

Oct. 1, 2013, 8:26 p.m.

A foolish inconsistency is the hobgoblin of little minds

Should obviously read a foolish consistency….

Hilarious misquote, is that in the book too?