All You Need to Know about Powells Interest Critical

All You Need to Know about Powells Interest Critical

16 May 2019 from Mikael Syding

The billionaire Jerome Powell is one of the world's most important persons.
Hayden, or "Jay" as he is called, has a background as a lawyer and investment banker. Jay's been fine. His wealth is estimated at about SEK 1 billion. Fun for him, but actually good for you and me as well.

In theory, the money should make it possible for him to do his job as head of the US central
bank without taking into account whether President Trump would threaten to destroy Jerome
Hayden Powell's career. Hayden has the world's most important job because he determines the
price of money, or rather the time preference for money - how careful it is to have the money in
his pocket today or tomorrow.

Powell's pivot
Suddenly, Jay made a turnaround and went from interest rates to interest rate doves. Powell
suddenly appeared as equally guided by the stock market and President Trump as Bernanke,
Yellen, Draghi and Greenspan. So was Jerome Powell a "market man," rather than the
independent patriot world economy needs?

Some have described it as "the removal of his spine was carried out with complete success." Is
not even a billion now enough to stay straight when the stock market falls and Trump shouts
red? Or is it perhaps something completely different that is going on?

Of course, the stock market fell a bit, when many had rather hoped for a classic Christmas rally,
but that was not what shook the Fed boss. It was that General Electric's bonds started trading
as junk, as "junk bonds," after downgrades of first S&P and then Moody's. For many weeks after
that, no single new bond issue was made. It risked getting the entire credit market to freeze,
which was what caused the crash after Lehman Brothers 2008. Since the credit market,
especially for low credit ratings, is much larger now, it could lead to a financial meltdown.

Powell was thus forced to save the credit market with the side effect that listed companies could
issue new bonds and start buying back their own shares again. At the same time, China
maximized its incentives to offset the lowest growth rates of 30 years, which together with
Powell's "pivot," gave rise to the strongest annual stock market launch in 30 years.

It is in the light of these events that the latest communication from the Fed should be seen.
Powell is not a market man when it comes to everything. He just wants to save the US
economy.

Now that the worst threat from the credit market is out of the way, the most important thing is
absolutely not to "provide for security" extra support in the form of interest rate cuts or reduce
QT in advance. On the contrary, it is important to use every sign of strength for the economy to
raise interest rates high enough to make a difference in the next recession. That's how you can read Powell.

Incidentally, the recession may be closer than you may think.

Where are we really in the economic cycle?
One can measure the economic situation in one hundred different ways. Some of the most
common are via the labor market, loan data, interest rate movements, purchasing managers
surveys, credit management indexes, wage developments, credit card problems, hotel data
(prices and occupancy) and consumer confidence.

 

Only that there are so many different indicators suggests that none of them work particularly
well.

Either the series gives too many erroneous signals, or the signals will be so late that they can
still be used. But, just like with the weather and other complex systems such as biological and
psychological processes, economic events have so-called "strange attractors," ie recurring
areas and turning points that have similar combinations of different variables.

Unfortunately, however, today's combination is unusual, due to the extreme monetary policy of
the past decade, as well as an extremely long but at the same time unusually weak economic
recovery.

So it is a little difficult to say whether it is a boom or a recession, and if it has been going on for
an unusually long time or has hardly begun!

Some things can in any case be noted, for example that the valuation multiples on the stock
exchange are the highest ever, while unemployment is very low and lending is extremely high.

With these measures, the US is in a burning boom where optimism is at the top of both lenders
and borrowers, and where both companies and private individuals are happy to buy shares for
borrowed money. Thanks to low debt rates and high employment, but without the need for high
wages, corporate profit margins and profits are at the same time record high. Further light
With these measures, the US is in a burning boom where optimism is at the top of both lenders
and borrowers, and where both companies and private individuals are happy to buy shares for
borrowed money. Thanks to low debt rates and high employment, but without the need for high
wages, corporate profit margins and profits are at the same time record high. Furthermore,
optimism sheds light on new listings, where almost all new companies on the stock exchange
report losses but still enjoy multi-billion valuations.

Finally, the US yield curve has recently been inverted, which has been a clear sign of a coming
recession.

Profits, borrowing, optimism, IPOs and valuation multiples thus proclaim the boom, while wages
and interest rates indicate recession (and at the same time, both gains and valuations provide
an extra boost). The combination is dangerous regardless of whether you are a private investor
with a focus on stocks, or the Fed chairman who wants to create an interest-rate buffer for the
next recession without causing an economic collapse through the credit market.

Inverted interest rate curve means time is of the essence

 

In this perspective, one understands that Powell gives double signals. He is an interest hawk
with respect to shares but a pigeon with respect to the credit market.

Implications for stock investors: Hedge your positions
For those of you who invest in shares, this means that there is both a Fed-put and not. This
means increased uncertainty about the Fed's decision, but with a trend of rising policy rates,
regardless of whether the stock market falls, as long as the credit market does not lock.

The stock market can be said to be governed by a combination of two things: partly underlying
fundamental variables such as sales and profits, and partly which valuation multiple investors
want to put on these variables.

The multiples are in turn determined by the availability of liquidity (including loans) and by which
optimism liquidity is put into work.

Right now, the fundamental variables are pressed up close to the max, thanks to many at work,
optimistic workers and consumers, as well as low interest rates. At the same time, the valuation
multiples are high, largely driven by the same factors.

If you do not believe that the business cycle has been abolished by Fed's frequent use of
banknote presses, then a period of both lower fundamental variables and a subdued optimism
(lower valuation multiples) will soon be waiting. Even if you want to keep in your favorite shares
then, you can secure the downside for the market in general with different index instruments.

As little as the Fed could save the stock market in 2002 and 2008, Powell will neither try nor be
able to do so this time. His assignment concerns the economy, not the stock exchange, and
even though he has an inherent pigeon, it mainly concerns the credit market and the economy's
long-term health.

On the other hand, you should be prepared for the fact that it was not the last time the Fed
increased its economic stimulus in a panic over credit market risk, so more big and sudden
stock market launches are likely to come. This means that no matter how negative you are to
shares, it is an equally losing strategy to try to lay cards all the way down.

So will the Fed stimulate or tighten? The answer is yes. On both issues. And will it cause stocks
to rise or fall in the United States (and Europe which is still always a pale copy of the US since
the best people moved there 100-150 years ago)? Yes.

Important legal information

Legal notice

This information is in the sole responsibility of the guest author and does not necessarily represent the opinion of Bank Vontobel Europe AG or any other company of the Vontobel Group. The further development of the index or a company as well as its share price depends on a large number of company-, group- and sector-specific as well as economic factors. When forming his investment decision, each investor must take into account the risk of price losses. Please note that investing in these products will not generate ongoing income.

The products are not capitalprotected, in the worst case a total loss of the invested capital is possible. In the event of insolvency of the issuer and the guarantor, the investor bears the risk of a total loss of his investment. In any case, investors should note that past performance and / or analysts' opinions are no adequate indicator of future performance. The performance of the underlyings depends on a variety of economic, entrepreneurial and political factors that should be taken into account in the formation of a market expectation.

15/06/2019 22:43:30

 

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