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Not that anyone expected him to, but Greenspan made no reference to baseball innings during his opening comments and surprisingly no one asked him that direct question. Instead Greenspan said the same thing he and the Fed, sans Fisher, have been saying: solid economic growth as the soft patch earlier was not so soft, inflation well contained, interest rates need to be hiked at a ‘measured pace,’ and the falling long term rates in the face of rising short term rates was still a puzzle That was just about it. No mention of where the Fed is or how long it is going to raise rates, just the same old plodding ahead. The market didn’t like it at first but then managed to get comfortable with it; after all, the Fed Funds Futures say two more rate hikes ahead with an outside chance at three. With that underlying all of the discussion, the market was not going to dive on the same rhetoric heard for the past couple of months.
Of course there is something to worry about, something that is nagging the market right now. Greenspan reiterated his position that the falling longer term rates in the face of his rising short term rates and the potential for an inversion of the yield curve does not necessarily mean anything bad for the economy. That alone should make sober man take pause. As noted earlier this week, that is tantamount to saying Greenspan and the Fed know better than the market. Nobody but nobody knows better than the market. The Fed proved it did not know more than the market in 2000, and it is about to do the same thing here.
What do we mean? Back in late 1999 and early 2000 the yield on the 10 year was falling even as the Fed was raising short term rates. The economy appeared strong at the time (the phrases ‘red hot’ and ‘white hot’ in describing the economy back then were known to cause some of the staff to become physically ill) -- hey the Fed told us it was -- so rate hikes seemed appropriate. As we were warning in our reports, however, the economy was not that strong and was decelerating already. There were tale tell signs it was happening, not the least of which was a wildly volatile stock market. In any event, the Fed hiked rates that final 50 basis points in April, and that brought the inversion. The market continued to sell and the economy continued to slow until it officially hit recession. The ride down even before the recession was official, however, was not pleasant. We went from a ‘red hot’ economy to a flat economy in less than 3 quarter. GDP growth dropped from 10+% to nothing in that time, a sickening drop. To say there was no recession at that time is to ignore reality.
Now we are in 2005 with the Fed close to its year anniversary of rate hiking. The Fed is saying the economy is strong despite a manufacturing sector that is teetering on contraction, a sputtering jobs market, slowing business investment, and oil above $50/bbl. The Fed is hiking short term rates again and the 10 year treasury is falling to meet the short term rates. Just as in April 2000, a 50 BP hike right now would invert the curve because there is less than 50 BP between the 2 year and the 10 year yields. The Fed is not going to raise by 50 BP, but it has two 25BP hikes baked in the cake. If the current trends remain, the yield will invert before summer’s end.
Back in 2000 the Fed thought the economy was too strong and thought it could invert the yield curve without a problem. Big mistake. Today, five years later Greenspan said that he did not think that an inverted yield curve would cause the problems as in the past. How does the song go? A little bit of history repeating . . . We said it before: the Fed talks a good game about using the data to make its decisions, but when it gets to hiking it wants to hit its target and it will fudge the numbers or look at them the way it wants to rationalize or sell its position on rate hikes.
Unfortunately, as in 2000 the Fed has many apologists ready to support its decisions (we called them ‘ring kissers’ in 1999 and 2000). One was on a financial station today stating that even if the Fed hikes the still low interest rates would drive the economy, inverted curve or not. His premise was there was a strong economy and when couple with low rates there would be all the incentive necessary to continue growth. Major flaws. Indeed it was almost incredible he was on the air spouting this shallow thinking.
First, most thought the economy was ‘red hot’ back in 2000; it must have burned up it was so hot because within a year huge growth was no growth and then contraction. The Fed is now convinced the economy is strong, but as noted, the growth that was in 2003 and 2004 is not there right now. At best the economy is maintaining the advance, i.e. holding the status quo. It may just be a down cycle in an overall uptrend, but there are other issues to consider as pointed out above.
Second, an inverted curve does not care how low the rates are; inverted is inverted. There is not a time in history that an inverted curve was not met with recession or at least a severe economic slowdown. The kicker: it DOES NOT MATTER how low rates are; they can be 0% and still no economic gains or recovery. Look at Japan’s 15 year depression. Its rates are at 0% and it cannot get off the floor. Further, the erstwhile pundit could not understand that low rates do not matter if you cannot get your hands on the money. The Fed has drastically shrunk the money supply this year. In 2004 it crimped supply to start the year, but it then let levels rise again. It has been bleeding down supply this year, and it is not coming back up. Indeed it is getting tighter and tighter. As in 2001 and 2002 after the Fed started cutting rates, the economy still went nowhere because the Fed did not grow the money supply right away. Rates were lower but there was not enough money, and the small businesses got the shaft. Right now rates are low but banks are already squelching loans because there is an unofficial word out in the community to tighten up and toughen up on loans. The Fed has made sure the point is getting across because it has dropped money supply sharply. In short, you may have the best boat and fishing tackle made to find and catch fish, but if there are no fish in the lake you are going to go home with one expensive sunburn.
The Fed is drying up money supply as it did in early 2000 and it is getting harder and harder to get money to do business. Some big corporations have a lot of cash, particularly the oil companies, and the Fed knows this so it assumes that there is plenty of liquidity to go around. You have to remember, however, that companies have remained strikingly pessimistic in this recovery, a holdover from getting burned badly by the Fed’s market and economy crash of 2000 and 2001. Just look at the ISM and ISM services index; pessimism among the business community is heading toward flat. Despite the money in the bank CEO’s fear the Fed and what it can and is doing to the economy. Everyone genuflects toward Greenspan (or makes the sign of the cross a la Tucco in ‘The Good, the Bad and the Ugly’) in public but then builds a bomb shelter in private.
To sum up, the answer to the old question the high school student asks as to why we study history is so clear. History repeats because human emotion never changes. The smart person knows history and why it repeats, and recognizes when the stars start lining up again. Right now the Fed is playing a dangerous game once more, the same one it played in 2000 and in years prior. The game’s conclusion is not forgone because the curve is not inverted and, importantly, the stock market has rallied and is now consolidating for another move. It has a good record of sniffing out when the Fed is just about done with rate hikes, but it is not infallible; it started such a move in the second half of 2004 but then gave it back when it proved wrong.
Thus the game is still on, and we do take heart from the market, but we remain cautious because of the Fed. It is a shame that the Fed feels it has to take on prosperity, intentionally or not, to get interest rates back up to where it feels it has some ammunition to handle the next crisis, a crisis that ironically might be caused by the rate hiking itself. Sounds like something out of the ‘Matrix’ but that is about the size of it. The economy might not be booming, but it has been expanding and creating new jobs and new companies. It is nowhere near recovering what was lost as a result of the last Fed tightening and here we are now with the Fed close to cutting short the rebound before it reaches its potential. When you see that history repeating it drives you crazy.
Of course there is something to worry about, something that is nagging the market right now. Greenspan reiterated his position that the falling longer term rates in the face of his rising short term rates and the potential for an inversion of the yield curve does not necessarily mean anything bad for the economy. That alone should make sober man take pause. As noted earlier this week, that is tantamount to saying Greenspan and the Fed know better than the market. Nobody but nobody knows better than the market. The Fed proved it did not know more than the market in 2000, and it is about to do the same thing here.
What do we mean? Back in late 1999 and early 2000 the yield on the 10 year was falling even as the Fed was raising short term rates. The economy appeared strong at the time (the phrases ‘red hot’ and ‘white hot’ in describing the economy back then were known to cause some of the staff to become physically ill) -- hey the Fed told us it was -- so rate hikes seemed appropriate. As we were warning in our reports, however, the economy was not that strong and was decelerating already. There were tale tell signs it was happening, not the least of which was a wildly volatile stock market. In any event, the Fed hiked rates that final 50 basis points in April, and that brought the inversion. The market continued to sell and the economy continued to slow until it officially hit recession. The ride down even before the recession was official, however, was not pleasant. We went from a ‘red hot’ economy to a flat economy in less than 3 quarter. GDP growth dropped from 10+% to nothing in that time, a sickening drop. To say there was no recession at that time is to ignore reality.
Now we are in 2005 with the Fed close to its year anniversary of rate hiking. The Fed is saying the economy is strong despite a manufacturing sector that is teetering on contraction, a sputtering jobs market, slowing business investment, and oil above $50/bbl. The Fed is hiking short term rates again and the 10 year treasury is falling to meet the short term rates. Just as in April 2000, a 50 BP hike right now would invert the curve because there is less than 50 BP between the 2 year and the 10 year yields. The Fed is not going to raise by 50 BP, but it has two 25BP hikes baked in the cake. If the current trends remain, the yield will invert before summer’s end.
Back in 2000 the Fed thought the economy was too strong and thought it could invert the yield curve without a problem. Big mistake. Today, five years later Greenspan said that he did not think that an inverted yield curve would cause the problems as in the past. How does the song go? A little bit of history repeating . . . We said it before: the Fed talks a good game about using the data to make its decisions, but when it gets to hiking it wants to hit its target and it will fudge the numbers or look at them the way it wants to rationalize or sell its position on rate hikes.
Unfortunately, as in 2000 the Fed has many apologists ready to support its decisions (we called them ‘ring kissers’ in 1999 and 2000). One was on a financial station today stating that even if the Fed hikes the still low interest rates would drive the economy, inverted curve or not. His premise was there was a strong economy and when couple with low rates there would be all the incentive necessary to continue growth. Major flaws. Indeed it was almost incredible he was on the air spouting this shallow thinking.
First, most thought the economy was ‘red hot’ back in 2000; it must have burned up it was so hot because within a year huge growth was no growth and then contraction. The Fed is now convinced the economy is strong, but as noted, the growth that was in 2003 and 2004 is not there right now. At best the economy is maintaining the advance, i.e. holding the status quo. It may just be a down cycle in an overall uptrend, but there are other issues to consider as pointed out above.
Second, an inverted curve does not care how low the rates are; inverted is inverted. There is not a time in history that an inverted curve was not met with recession or at least a severe economic slowdown. The kicker: it DOES NOT MATTER how low rates are; they can be 0% and still no economic gains or recovery. Look at Japan’s 15 year depression. Its rates are at 0% and it cannot get off the floor. Further, the erstwhile pundit could not understand that low rates do not matter if you cannot get your hands on the money. The Fed has drastically shrunk the money supply this year. In 2004 it crimped supply to start the year, but it then let levels rise again. It has been bleeding down supply this year, and it is not coming back up. Indeed it is getting tighter and tighter. As in 2001 and 2002 after the Fed started cutting rates, the economy still went nowhere because the Fed did not grow the money supply right away. Rates were lower but there was not enough money, and the small businesses got the shaft. Right now rates are low but banks are already squelching loans because there is an unofficial word out in the community to tighten up and toughen up on loans. The Fed has made sure the point is getting across because it has dropped money supply sharply. In short, you may have the best boat and fishing tackle made to find and catch fish, but if there are no fish in the lake you are going to go home with one expensive sunburn.
The Fed is drying up money supply as it did in early 2000 and it is getting harder and harder to get money to do business. Some big corporations have a lot of cash, particularly the oil companies, and the Fed knows this so it assumes that there is plenty of liquidity to go around. You have to remember, however, that companies have remained strikingly pessimistic in this recovery, a holdover from getting burned badly by the Fed’s market and economy crash of 2000 and 2001. Just look at the ISM and ISM services index; pessimism among the business community is heading toward flat. Despite the money in the bank CEO’s fear the Fed and what it can and is doing to the economy. Everyone genuflects toward Greenspan (or makes the sign of the cross a la Tucco in ‘The Good, the Bad and the Ugly’) in public but then builds a bomb shelter in private.
To sum up, the answer to the old question the high school student asks as to why we study history is so clear. History repeats because human emotion never changes. The smart person knows history and why it repeats, and recognizes when the stars start lining up again. Right now the Fed is playing a dangerous game once more, the same one it played in 2000 and in years prior. The game’s conclusion is not forgone because the curve is not inverted and, importantly, the stock market has rallied and is now consolidating for another move. It has a good record of sniffing out when the Fed is just about done with rate hikes, but it is not infallible; it started such a move in the second half of 2004 but then gave it back when it proved wrong.
Thus the game is still on, and we do take heart from the market, but we remain cautious because of the Fed. It is a shame that the Fed feels it has to take on prosperity, intentionally or not, to get interest rates back up to where it feels it has some ammunition to handle the next crisis, a crisis that ironically might be caused by the rate hiking itself. Sounds like something out of the ‘Matrix’ but that is about the size of it. The economy might not be booming, but it has been expanding and creating new jobs and new companies. It is nowhere near recovering what was lost as a result of the last Fed tightening and here we are now with the Fed close to cutting short the rebound before it reaches its potential. When you see that history repeating it drives you crazy.