Pretty Dovish FED

As I expected the FED statement and the Jay Powell press conference show that the FED is turning neutral with a dovish tone.

As always the FED will be data dependant, but they are evaluating the need to change the ‘balance sheet’ runoff–I assume from the current $50 billion/month rate.

As I read the statement I see a dovish approach to further rate hikes–still with the June possibility, which we had forecast for 2019. We believe they will reduce the balance sheet ‘runoff’ to 1/2 the current rate (in the $25 billion/month range). Additionally I believe they will ultimate target a balance sheet level of $2 trillion. This contrasts with the $1 trillion balance sheet that we started quantitative easing with way back in 2008. The balance sheet topped out at the $4.5 trillion level and now stands around $4 trillion.

So in summary I believe that all the data that is released each month will very much drive the FED funds rate–more so than it already does, so we need to watch employment and inflation closely. Rate hikes will only occur if they are warranted, primarily by inflation. The balance sheet ‘runoff’ will change to a more dovish level.

All of this likely bodes well for investors–both common share owners as well as preferred and baby bond holders. With this dovish tone the 10 year treasury, which was up 2 basis points to 2.73% earlier today, is now falling and is off 1.3 basis points at 2.699% as we had surmised would happen.

With this now out of the way for the time being we can turn our attention (as investors) to the problems of Federal government deficits and trade policy.

12 thoughts on “Pretty Dovish FED”

  1. I have written many times about the enormous debt level and my concerns. This crushing debt seems to be the real Sword of Damocles overhead to me of our great economic life. This may be of interest to some of you:
    January 31, 2019
    Bogota, Colombia

    We write a lot about global debt levels at Sovereign Man.

    In fact, the very first Notes from the Field I ever wrote, in June 2009, was about how broke the US was… and the severe consequences that eventually face a nation that recklessly spends money it doesn’t have.

    And debt has been a major theme in this publication ever since.

    As you know, since the Great Financial Crisis in 2008, debt levels have only gotten worse. But not just for governments.

    Sovereign debt, corporate debt and consumer debt are all at all-time highs.

    The US government has $22 trillion of debt and is running $1 trillion+ deficits every year. There’s a record $15 trillion of corporate debt. And the US consumer has racked up around $4 trillion of debt (not including mortgages).

    And you don’t have to take my word for it that this is all going to end badly…

    Last week, one of the most respected hedge fund managers in the world came out with a warning scarier than anything we could have dreamed of.

    Seth Klarman runs the $28 billion hedge fund, Baupost Group. The guy is famously secretive (and conservative). So the fact that he went out of his way to make this public statement means you should pay attention.

    Also, Klarman’s fund is closed (he’s actually been returning money), so he’s not doing this to scare people into investing in his fund.

    In a 22-page letter to his investors, Klarman warned that government debt levels, particularly in the US (where debt exceeds GDP), could lead to the next global financial crisis.

    “The seeds of the next major financial crisis (or the one after that) may well be found in today’s sovereign debt levels,” he wrote.

    In addition to debt levels, Klarman is worried about the increasing social unrest (something we’ve written about in detail) and the public’s inability to decipher who is telling the truth these days between politicians and the media… both of which make it difficult for a capitalist system to thrive.

    Who knows what will ultimately bring the system crashing down, but let’s focus on the US government’s exploding deficits…

    In 2018, the federal government’s deficit hit $1 trillion. But these are “good times,” with soaring asset prices, solid corporate profits and record-low unemployment.

    What happens when a recession inevitably occurs? Our friend Jim Grant of Grant’s Interest Rate Observer, says the deficit will blow out to $2 trillion.

    So, $22 trillion in the hole and a $1 trillion deficit in a good year. Not to mention, interest rates are rising, which means all of this debt is just getting more expensive.

    Eventually, people will simply refuse to lend Uncle Sam any more money… because they know there’s no way they’ll be repaid.

    And we’re already seeing signs of that.

    According to the Wall Street Journal, in the first eight months of 2018, overseas buyers of US Treasurys only bought half the amount they did over the same period in 2017.

    From Klarman:

    “There is no way to know how much debt is too much, but America will inevitably reach an inflection point whereupon a suddenly more skeptical debt market will refuse to continue to lend to us at rates we can afford…”

    And when fewer people want your bonds, that means it’s more expensive to borrow. But the government can’t afford to pay any more…

    The government already spends 28% of its revenue just on interest (at a time when interest rates are near all-time lows).

    Ultimately, Klarman believes the debt (along with the massive wealth disparity caused by a 10-year asset price boom) will lead to social unrest…

    “It is not hard to imagine worsening social unrest among a generation that is falling behind economically and feels betrayed by a massive national debt that was incurred without any obvious benefit to them.”

    Again, this isn’t Sovereign Man speaking… it’s a bespectacled hedge fund manager out of Boston.

    Another line from Klarman that comes straight from Notes… “By the time such a crisis hits, it will likely be too late to get our house in order.”

    But Klarman isn’t the only billionaire alerting the public right now…

    At the recent Davos gathering, Ray Dalio, founder of the world’s largest hedge fund, said he thinks the next downturn will be worse than the Great Depression.

    And like Klarman, Dalio says the problem comes down to too much debt…

    “The biggest issue is that there is only so much one can squeeze out of a debt cycle and most countries are approaching those limits”.

    The world is drowning in debt. And there’s no austerity measures in sight. In fact, a rising tide of socialist politicians want to explode government spending (paying for free healthcare, education and everything else under the sun).

    We don’t know when this monetary experiment will end. The European Central Bank and Bank of Japan both essentially reneged on their plans to start tightening monetary policy. And yesterday, the Federal Reserve has signaled it will stop hiking rates.

    Global central banks, it seems, have already given up on their weak attempts to tighten… fearing the economy wouldn’t hold up.

    If they step back on the gas of QE, I believe that’s the point when people lose faith in fiat… and the US dollar specifically.

    And while this all goes down, the central banks (who control the printing press) have been buying gold at the fastest pace in years. You may want to consider doing the same.

    Gold is one of the few asset classes that hasn’t risen to absurd heights. But it may be coming back to life… the metal rallied to an eight-month high this week.
    To your freedom,
    Simon Black,

  2. I’ve been at it all day over here. Looked over everything. I get the impression the people are reaching here…strictly judging by price action. Good thing to work on during a 4′ day.
    I’ve place sell limits to pare if hit or hold them; I’ll take the divy if not hit. Placed a few buy limits which are kind of useless on thinly traded stocks since the pros can see them, but only one ones I’ll take on my terms to improve portfolio even if the market tanks. The last of my income stocks (equities) are near or above call option prices and are not calendar rolling out a month or two, so ‘feeling’ a topping. I’ll let them go if called.

    1. Joel, doesnt sound you had it much warmer 50 miles to the north of me, lol.
      Stay warm. Yep you know things are slowing down when my two flips were just selling and buying back the same issue today, lol.
      The corporate bond/treasury spread would support your case, Joel. The spread was a skimpy 159 basis points in January 2018. It peaked Jan. 2 this year at 245 basis points. It has now only dropped back to 236. So the spread has not narrowed much at all, but the preferreds roared back anyways.

  3. The Fed statements should certainly add stability to income issues over the coming weeks.

    1. Gary – I think we would have ‘Goldilocks’ times if the politicians would get their act together.

      1. Agreed. The federal debt ceiling suspension expires March 2. That is 13 legislative days from now. Isn’t that also about the time the 90 day freeze on US- China tariffs expires unless extended?

  4. I’m happy that Fed actions will be data dependent and having a pause while we see if there is a second government shut down is a very wise thing.

    I’m curious about something I saw in a WSJ blog (below).

    – If the Fed purchased the paper and has it on it’s balance sheet, why is it paying interest? Who is it paying interest to?

    – Does the rate fluctuate daily?

    The Background on That Fed Special Statement
    The Fed’s special statement provides some resolution, for now, to a debate that Fed officials have been having about the ultimate size of the Fed’s balance sheet.

    As our colleague Nick Timiraos noted in that story, “The Fed’s decision about the size of its portfolio is being driven by a technical debate inside the central bank about reserves in the banking system, not over whether officials want to provide more or less stimulus to the economy.”

    This is quite technical, but in the past, the Fed conducted monetary policy with a very small number of excess reserves in the system, and instead guided interest rates by selling and buying bonds in the overnight Fed funds market. But now the Fed has the ability to pay interest on these reserves, and it intends to continue using this rate, which it sets directly, as its primary tool for raising (and maybe someday lowering) rates.

    1. Hi Greg–the Fed collects interest on the balance sheet per the terms of any security they own (whether it be treasuries or mortgages).

      I will have to get a look at the WSJ item you linked.

  5. I agree with you 100%. To me, this is great news. The data will drive their decisions – that’s all we can ask for.

    Did the Fed do the right thing in 2018? Yes, we had to get the Fed funds rate at or near the inflation rate. The discussion of overshooting neutral is what really caused the market distress (in my view).

    I don’t describe this as “dovish”, to me they simply have absolutely stopped being “hawkish” and are truly neutral and patient.


    1. I agree SteveA–I was for Fed Rate Increases and for balance sheet reduction, but we now have to kick back in the easy chair a bit and see what happens.

      1. Funny you said that…I just did. I am learning. From experience and from the incredible knowledge here. The hardest thing to do sometimes is nothing. I’m about 30% cash right now which I hate, but feels right now. Big purchase this week was the C corporate note at 3% til 1-2020. Should give me a grand a month for first year of retirement. Thanks to one of the writers here who mentioned it.

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