I watched intently as newly seated Fed Chair Jerome Powell delivered his first testimony to the House Financial Services Committee earlier this week. For the most part, he said about what I expected in response to congressional leaders, many of whom were clearly showboating for the cameras.
It was hard to not waffle between feeling like I wanted to scream at the TV or yawn at the predictability of it all. Turn off the volume and the session would make a good substitute for Animal Planet.
Then came Rep. Carolyn Maloney’s (D-NY) question about what could cause the Fed to raise rates more than the three times that the Fed’s most recently issued guidance calls for.
Powell wasted no time stepping in it.
I don’t know whether that was intentional or if he simply made a rookie mistake. Either way, that really doesn’t matter much in anything other than an academic setting (which is of course what the Fed is) or a political talk show.
Yields jumped to fresh highs and stocks marched sharply lower in minutes when Powell made the case for the possibility of more rate hikes than forecast, saying in classic Fedspeak that “each of us [meaning FOMC members presumably] is going to be taking the developments since the December meeting into account and writing down our new rate paths as we go into the March meeting, and I wouldn’t want to prejudge that.”
I’ve been watching global markets for 35 years and I knew right away what Powell meant because I have a functional Ph.D. in interpreting Fedspeak and applying it to financial markets – not literally, of course, but figuratively.
Fedspeak, in case you’re not familiar with the term, is what traders euphemistically call the highly specific, ultra-confusing language used by Fed chairpersons (specifically) and Fed governors when they are making public commentary or, as was the case here, appearing in front of lawmakers and TV cameras.
Fedspeak typically has no bearing on reality, and is used most frequently when the person being questioned does not actually want to answer the question being asked or simply hopes the level of technical detail will overwhelm the questioner to the point where he or she moves on. In exceptionally rare cases, Fedspeak is actually used to communicate.
All sarcasm aside, imagine asking a five-year-old,
What happened to all the cookies in the cookie jar?
A fluent Fed-speaker might tell you.
…the preponderance of demand led to an asymmetrical increase in consumption prior to the regularly scheduled data point associated with evening intake production and delivery.
The five-year-old would have simply said, “I got hungry and had a snack before dinner.”
I’m exaggerating to make a point, of course, but not by much.
You and I would have answered Rep. Maloney’s question saying simply, “the economy is growing faster than we expected so it’s very likely that we may have to raise rates more frequently than we (the Fed) told you (the public) at the end of our last meeting.”
What Raising Rates More Than Expected Looks Like
Heading into his testimony, December Fed meeting notes called for three rate hikes in 2018. Since then the economy has strengthened further – forcing the Fed to reassess its models. Jobs data, housing, consumer optimism… all are sharply higher, which means, presumably, that inflationary pressures are building.
I believe we’ll get four, perhaps even five, rate hikes, and I say that because real inflation – meaning what you and I experience in our wallets – is running at double or even triple the official rates calculated by the Beltway Boys. Simply put, there’s some catching up to do.
That’ll mean more volatility ahead as the “game” continues and the news outlets dissect each new comment from Fed officials in excruciating detail. However, I’m not particularly worried unless rates top 4.5%, at which point all bets are off.
Don’t get me wrong, though.
We all know that endless stimulus and “accommodative” policies will end badly. That’s beyond debate because there has never been a recorded instance in market history where rising rates have not ultimately led to a market correction.
The only questions are when, what causes it, and what do you do in the meantime?
The “when” is straightforward.
The average recovery cycle has been 44 months over the past 60 years, during which time there have been three massive shifts in financial engineering, debt, and leverage from the 1980s to 2000, according to Bloomberg data. The average number of months from the first rate hike to the next recession is 33, while the average five-year real economic growth rate has been 3.08%.
Simple extrapolation means we’re on track for mid-2019.
Interestingly, I first identified that date range based on cycle work I did related to the Internet bubble nearly 20 years ago. Frankly, I didn’t expect that and was surprised when I dug out my notes – but that’s a story we’ll continue another time because clusters of data points are often significant in their own right.
Anyway, what matters most for purposes of our discussion today is that mid-2019 is when the Fed’s targeted rates, real growth, and the 10-year note potentially align, causing both another serious correction and a recession at the same time.
You can see that relationship very clearly in the following chart – which I’ve annotated to make my point.
That’s why the markets pitched a fit – Powell’s plans to possibly raise rates faster and more often than expected brings us closer to the nexus.
I wouldn’t blame you one iota if you want to run for the hills just now. However, that’d be a serious mistake.
Corrections start when the last buyers have arrived at the party. There’s usually a massive spike higher as money chases hope, which springs eternal in only two places on earth I’m aware of – Las Vegas and the New York Stock Exchange.
So now what?
First, the real story is still growth, growth, and more growth. That’s why you can ignore most of the verbal judo you’re going to hear in the months ahead about rate hikes, how many points, when, etc.
Second, invest only in short- and mid-term bonds. That will help you get around most of the volatility that’s going to plague income-related bonds and bond funds.
Third, continue to play offense even as you invest defensively in companies that can hedge inflationary pressures. Right now that’s big defense, big tech, and big medicine – like the two companies I’m recommending in the hot-off-the-presses March edition of the Money Map Report scheduled to go live tomorrow! Click here for more information.
The key to getting through a correction you know is coming without losing your asteroids is something we talked about in the most recent Total Wealth weekend edition – “no sudden moves.”
To paraphrase something Warren Buffett once said: “If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.”
*This has been a guest post by Money Morning*