Wednesday, July 15, 2020

Best Friends Forever: Powell, Mnuchin, & Stock Investors

What's been driving the stock market meltup since March 23? First and foremost, of course, is the Fed’s shock-and-awe monetary policy response to the Great Virus Crisis (GVC). It has been shockingly awesome! So has been the fiscal policy response. Never before has so much monetary and fiscal stimulus been provided in such a short period of time in response to an economic and financial crisis. It’s actually much more than the virus-challenged economy can absorb, which explains why stock prices are soaring. Consider the following:

(1) The Fed is our friend. Technicians like to say “Let the trend be your friend.” I agree; but from a fundamental perspective, my mantra has long been “Don’t fight the Fed.” Indeed, that’s the main theme of my recently published book, Fed Watching for Fun & Profit.

My book concludes with the events of 2019. I’m working on a follow-up tentatively titled The Fed Fights the Virus. Enough has happened since the start of this year to write a second volume rather than an update to the first book. For now, let’s cut to the chase: By pushing the yield curve close to zero in response to the GVC, the Fed left investors no choice but to either earn close to nothing on their fixed-income securities or rebalance into stocks, which is what many have done since March 23.

Ever since then, Fed officials repeatedly have stated that they intend to keep interest rates close to zero for a very long time. As Fed Chair Jerome Powell famously said at his June 10 press conference: “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates.” In a Freudian slip, Powell said that monetary policy is in “a good place,” as “we’re continuing asset prices in coming months … at a relatively high level.” A footnote in the transcript stated: “Chair Powell intended to say ‘asset purchases’ rather than ‘asset prices.’”

When asked whether he is concerned about high asset prices, he made it clear that the Fed’s main concern is getting through the GVC by “pursuing maximum employment and stable prices.” He added: “we’re not focused on moving asset prices in a particular direction at all. It’s just we want markets to be working, and I think, partly as a result of what we’ve done, they—they are working. And, you know, we hope that continues.” He clearly rejected “the concept that we would hold back because we think asset prices are too high.”

In new projections released after the June 10 meeting of the FOMC, all 17 participants said they expect to hold rates near zero next year, and 15 of them projected that rates would stay there through 2022. As Powell concluded, “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates.”

Officials made one policy change at the meeting by announcing they would maintain their recent pace of purchases of Treasury and mortgage securities, effectively ending gradual, weekly reductions. They will buy at least $80 billion in Treasuries and $40 billion in mortgage securities, net of maturing bonds, a month (Fig. 1 and Fig. 2). Over the past year through the week of July 8, the Fed has purchased $2.1 trillion in Treasuries, financing 66% of the rapidly ballooning federal budget deficit (Fig. 3 and Fig. 4).

The Fed isn’t even thinking about the possibility that asset prices are too high. Yes, indeed, the Fed is truly our friend for the foreseeable future.

(2) The word at the Fed is “accommodative.” One of the reasons why the stock market rally is continuing so far this month is this: In the Minutes of the June 9-10 meeting of the Federal Open Market Committee (FOMC), released on July 1, the adjective “accommodative” appeared seven times.

For example: “Participants agreed that asset purchase programs can promote accommodative financial conditions by putting downward pressure on term premiums and longer-term yields.” In addition, the noun “accommodation” appeared six times in the context of monetary policymaking. The FOMC’s use of forms of this word have proliferated with the latest Minutes release; in the previous Minutes, for the April meeting, the adjective appeared just once, while the noun didn’t appear at all!

As you can see from the photo above, Fed Chair Jerome Powell and Treasury Secretary Steven Mnuchin are joined at their elbows if not at their hips. The Minutes reported: “Participants also regarded highly accommodative monetary policy and sustained support from fiscal policy as likely to be needed to facilitate a durable recovery in labor market conditions.” In other words, the Fed will continue to finance a large chunk of the federal government’s budget deficit. How long will the Fed do so? The Minutes stated, “Participants noted that a highly accommodative stance of monetary policy would likely be needed for some time ....” The Fed and the US Treasury are Best Friends Forever.

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