By Art Cashin Director of Floor Operations at UBS

November 12 (King World News) - This Is Becoming “An Agent Of Financial Recklessness”

Art Cashin - The Fed Under Stress – Part I – Here's a bit from our friend Peter Boockvar's note this morning:


“The US Treasury market is not waiting until December 18th to see what the Fed will do, it is instead continuing its attempt to tighten policy for them.  The process was interrupted on September 18th and somewhat in early October but has since resumed.  The 10 yr note yield at 2.77% compares with 2.85% on September 17th and with the close of 2.69% the day after when the FOMC didn’t take what the market was giving them.  This action begs the question that assuming we enter the December meeting with the exact circumstances we have today in terms of data and market levels, will the FOMC fool the market again or not?  Either way, what we are witnessing AGAIN is the bond market reasserting its power over the long end of the curve notwithstanding all the money being spent by the Fed.


Fisher spoke overnight in Australia and repeated again his concerns with QE.  “There’s a tipping point where monetary accommodation comes to be viewed not as the pleasant stimulus that levitates bond and stock and housing markets all over the world.  But, instead becomes an agent of financial recklessness.”


Fisher recognizes that markets are a bit confused as to the exact plans the Fed may have.  Here's another part of what he said:


“We could be in our own little monetary trap here because being data dependent doesn't really define for the market place where we will end this program or begin to taper back the current rate of purchases.”


The Fed is under further stress as more people claim that the Fed's policies have exacerbated the inequality factor in the U.S. (See today's WSJ Op-Ed – Confessions of a Quantitative Easer.)  If the concept that the Fed has only helped “the haves” takes hold, the Fed could become a political football.  That's why tapering needs to start sooner rather than later.


The Fed Under Stress – Part II – From Ray Dalio's letter last week (courtesy of another old friend, John Mauldin):


“In the old days central banks moved interest rates to run monetary policy. By watching the flows, we could see how lowering interest rates stimulated the economy by 1) reducing debt service burdens which improved cash flows and spending, 2) making it easier to buy items marked on credit because the monthly payments declined, which raised demand (initially for interest rate sensitive items like durable goods and housing) and 3) producing a positive wealth effect because the lower interest rate would raise the present value of most investment assets (and we saw how raising interest rates has had the opposite effect).


All that changed when interest rates hit 0%; “printing money” (QE) replaced interest-rate changes. Because central banks can only buy financial assets, quantitative easing drove up the prices of financial assets and did not have as broad of an effect on the economy. The Fed's ability to stimulate the economy became increasingly reliant on those who experience the increased wealth trickling it down to spending and incomes, which happened in decreasing degrees (for logical reasons, given who owned the assets and their decreasing marginal propensities to consume). ….. the marginal effects of wealth increases on economic activity have been declining significantly. The Fed's dilemma is that its policy is creating a financial market bubble that is large relative to the pickup in the economy that it is producing. If it were targeting asset prices, it would tighten monetary policy to curtail the emerging bubble, whereas if it were targeting economic conditions, it would have a slight easing bias. In other words, 1) the Fed is faced with a difficult choice, and 2) it is losing its effectiveness.”


Mr. Dalio goes on to ponder the apparent declining efficacy of Fed policy and what might happen if some exogenous event tipped the economy back into a new recession.  As the new Fed chair awaits confirmation, the Fed faces a policy dilemma – maybe even a couple.  More in coming days.”

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