Every day people regurgitate trite sayings without much thought. It seems typical of humans. Probably because there is comfort and reassurance in old sayings and comfort is what we crave in a world of change. Often this can be harmless. But, when blindly adopted as financial truth, this habit can be dangerous.
One such example is the old saw “Don’t fight the Fed.” This was originally used as a cryptic line to express the reality that if central bankers wish to lower short-term interest rates they have traditionally had monetary tools with which to do so. And for 30 years from 1982 to 2012, the central banks of the world have cut interest rates to increase money supply and entice discretionary consumption on credit. During those three long decades (a near lifetime for the Boomer generation) the most obvious manifestation of “Don’t fight the Fed,” has been in the bond market, where existing bond prices have increased substantially every time Central Bankers have slashed short term rates. Dividend paying stocks increased in value to a lesser extent but for the same reason (dividend income is not contractually required and so riskier than bond interest, but payments made do become more valuable each time prevailing interest rates fall). So the price people were willing to pay for stocks went up as interest rates fell. (Actually bond gains have beat stock gains for most of the past 200 years thanks to compound interest, but few people are interested in such facts. See this chart for more.) I digress. The fact is that in a financial world paid to sell the hope of stock wins, the sell side has seized on “Don’t fight the Fed” as the perfect mantra to keep new hopefuls perpetually flowing their capital into stocks. (All the while the same stock promoters have said bonds were for losers even while bonds beat stock returns.) But again, I digress.
The hard point is that most people today have insufficient savings and so opt to wager on blind luck and improbable wins: lottery tickets, gambling and stock markets at every price, regardless of the likelihood of retaining profits. A whole gaming and financial business has evolved in response to the preference for financial fantasy. Marketing to this demand, most in the money business are paid to promote the hype and hope of capital wins at all times and every price.
But as always, timing is everything, and today is the opposite of 1982. Today North American government bonds are not paying an anomalous 20%. Today rates are less than 2%. In 1982 the Fed had the luxury of two deciles of percentage points of stimulus to draw on. Today they have literally none. Developed world Central Banks are already paying virtually nothing today on overnight deposits. Some like Germany and the Netherlands are actually charging negative rates. When central banks had run to the end of their lower rate rope by 2010, and no traditional consumption rebound had revived, they resorted to last-straw desperate measures known as “quantitative easing”. For the past two years they have used this publicly funded purse trying to spark the flame of organic economic growth repeatedly to no avail. The stock market has sputtered through fits and starts each time with no lasting benefit. This chart of the downtrend of the Global PMI manufacturing index (blue) and the ridiculous and fleeting failings of the MSCI world stock index (gold) since 2010 says it all.
So back to a simple but crucial point about “Don’t fight the Fed.” The Fed has exhausted its monetary efforts of import. After 30 straight years of slashing rates in response to each period of stagnant growth, Central Banks are out of demand catalysts to throw at the economy. The now over-levered world has strung itself up in debt. The new mantra should now be “don’t fight math” or “don’t fight the secular demand cycle”. Either way it seems that the mindless magic of ‘add credit and stir’ is over for the next few years.
And finally coming full circle, if the US Fed is now impotent, then the US dollar should continue to strengthen in relief. And this should continue to undercut the assets that have enjoyed outsized gains on U$ weakness over the past 10 years. This would suggest further weakness for equities, commodities (including precious metals) and other “risk on” currencies like the Canadian dollar.
