Recession Obsession: What Causes Downturns And How Vulnerable Is The US?
"Recession obsession" has become a fixture of markets over the past three months thanks in no small part to the perception that the Fed has tightened the economy into a slowdown just as the tailwind from fiscal stimulus is set to wane.
We've variously argued that market participants began to lose track of their own role in shaping the narrative sometime in late November. The curve inversions that started showing up early last month added a sense of urgency to the recession calls and Jerome Powe
So…..can we now predict that the Fed can and will strangle the stock market at any time (for no justifiable reason, and in the absence of inflation)? Winding down the balance sheet can be done at a rational pace, as opposed to the reckless abandon which we recently witnessed from Powell and associates…Powell acted like the proverbial “Bull in the china shop”, with no finesse and no feel for the markets.
Is the pace of renormalization really reckless? I’m not an economist or financier, but if I’m reading this graph correctly, the Fed dumped about 150 billion in assets during 2018Q4:
https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
A quick Google search suggests that the velocity of the bond market is on the order of 700 billion per DAY.
At first blush, given the scale of money sloshing around in bonds, the daily rate of tightening doesn’t seem all that extreme compared to the size of the market.
Am I missing something?
No, not missing anything.
Compared to the Trillions (with a Capital T! :-)) of QE the amount of „normalization“ so far is miniscule.
The effects have been outsized, however.
It really makes you think about what lies ahead in the medium to long term:
More tightening resulting in even more severe sell-offs or a Fed caving to the market‘s demand for more accomodation?
But what would be the endgame of that?
The Fed going full BoJ, ending up owning entire markets?
It‘s hard to see a way back to normal, (whatever that means in these times) that isn‘t extremely painful.
Sunnydog, nice quote about feeling the markets, btw.
Accident or purpose?
Are we confusing correlation with causality, though? Many “news” factors influence the market, and we seem mired in entropy-generating factors: trade war, China/US cyclical inflection, and Brexit, to name a few. There are also the “operational” factors e.g. algorithmic trading strats that seem to heighten volatility.
What we saw in late December, was a dramatic sell-off triggered by a combination of bad trade-war news and some badly worded remarks from Powell. Granted, the Fed’s communication style has been atrocious, but the equities market wasn’t reacting necessarily to the amount of QT, but to the information that first rate hikes, then QT, would be conducted without regard for the state of the market. (I.e. the Fed seemed to be implying that they had severed the communication loop.)
You raise some good questions about the endgame: we don’t know what’s going on or how QT will impact equities, because it’s virtually unprecedented, and markets always treat uncertainty as bad news. Nevertheless, I suspect that with a more capable wordsmith at the helm of the Fed, and/or without an inflammatory POTUS to draw unnecessary attention to the process of QT, the December reaction would have been much less severe.
Are there any alternatives to a BOJ-style endgame, if the next recession gets severe enough? I sure hope so! Some sci-fi possibilities:
— Next round of QE is done via another mechanism e.g. helicopter money. (Might be a better choice than bank-to-Fed communication, in a society dominated by consumption.)
— Corporations find another way than stock to access capital, having decided that the equities market no longer does its job efficiently.
— Regulations change to eliminate some of the other volatility factors.
All of these would be unknowns themselves, of course, but compared to Japan-style stagflation and a “puppet market,” I’ll take the devil I don’t know.
granted, having a more “accomodative” (pun intended) president or Fed chair would certainly be an advantage in this situation.
You have a good point re.: helicopter money, it would probably have been the better choice in a consumer-oriented economy, plus it would have reduced the artificial asset-price inflation via debt-fueled stock buybacks.
However, as of now, with so much QE already in the books (on the Fed’s Balance sheet) I do not really see how “more cowbell” (to shamelessly steal a popular phrase from this site) will have further positive effects going forward. Too many people will assume that attempts at further re-flation will some day backfire, thus diminishing the intended effects before they can materialize.
Regulatory changes to reduce volatilty will need to be adressed by the next Administration.