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Cowley: 'Not the Fed's finest moment...'
by Stewart Cowley on Oct 04, 2013 at 15:16
It’s been difficult even for the most experienced of investors to tip-toe through the recent thought processes of the Federal Reserve. The miscommunications that started in May ended in a farcical volte face in September when they abandoned the idea of beginning the exit from quantitative easing (QE) (not actually ending it). The unintended result was to send long-term bond yields up by about 1.5%, drive the inflation-linked bond markets to the point of closure, propel corporate bond spreads up 1.6% and send the US dollar down by 5% against its trading partners. It wasn’t their greatest moment.
Still it doesn’t change the fact that this policy, which had its moment though that moment has now passed, will end one day. So how can investors gauge the actions of the Fed going forwards? We offer two things – money and employment. Capitalism, as Karl Marx observed, needs credit to create profits and ordinary people need jobs to survive. They are naturally, inextricably linked but one moves faster than the other – money.
There is an arcane and little looked at report called the H8 report that the Fed very kindly publish each week. In the tradition of over-analysis and paralysing surveillance that the US has become, the Fed gathers information on the lending and money-taking activities of selected commercial banks. And then they publish it, freely on the internet. The trends inside it are revealing.
First of all notice the recovery in bank credit growth between 2009 and into Q1 2013. Pump priming the economy worked; lending and the housing market rose and in 2009 the Case Schiller Home Price Index started to bottom out. By 2012 it was rising consistently again. But also notice that, either by coincidence or cause, bank credit growth began to go backwards as bond yields rose during the Fed’s fateful miscommunication in Q2 2013. It was more than likely that this evidence was in their minds when they backed away from pulling out of QE in September. On that basis the H8 report is something to watch closely going forwards. On current evidence the negative growth rates in bank lending do not argue for an early end to QE.
Secondly, on the employment front, the cumulative effect on employment in the US during the financial crisis was devastating. Some eight million jobs were destroyed in the 2007 to 2009 period. But thankfully there has been a gradual and consistent recovery in jobs. Of the eight million places lost, today, there remain just over a million to recover. For spurious accuracy, on the current trajectory, all the jobs lost in 2007 to 2009 will have been recovered by April 2014 if, on average, 177,000 non-farm jobs are created each month. The Fed would have every justification to back away from QE by this point. Of course, current chairman Ben Bernanke will have gone by then but in his own mind he will have the satisfaction of saying, “I inherited a problem. I dealt with it. I fixed it”.
Whatever the exact timing of the end of QE turns out to be, we know the bond markets are the senior partner in the financial markets and have a tendency to run ahead of official policies. We now know a misplaced word can have almost instantaneous effects on the financial markets and we can only hope they handle things better next time, but don’t count on it. All you can do is be ready for it when it comes.
Stewart Cowley is investment director, fixed income and macro at Old Mutual Global Investors.
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