I said I was going to talk a lot more about the two posts I highlighted here. First, I want to outline some observations I had while reading the two, then putting together some data we have seen, I’m going to try and describe a “new normal.” One where I think we’ll see periodic cyclical tailwinds that move us forward, but one that will also have a counter-current acting as a darg. Kind of like sailing the Volvo Ocean Race against the ocean currents. We will have winds to our backs periodically, but the current will always be there: smacking into us and knocking us around.
The post over at Trader’s Narrative is rich. The charts tell a wonderful story, but I want to focus on some of the things that are said. First, on the yield curve inversions:
- 1989: Almost immediately the Fed started an easing cycle (from 9.75% to 3%)
- 2000: Within about 2 months the Fed started on a sharp easing cycle (from 7% to 1%)
- 2006: The Fed dragged its feet, easing in August 2007 (from 6.25% to basically zero)
It’s subtle, but note what Fed funds have had to do: glide lower. The Fed never tightened monetary policy to where rates were during the previous cycle; they never get to a neutral position from a rates perspective:
Note also that each easing has dragged rates lower and lower. We’re now dealing with rates in a range from 0-25bps, where in the past there was a target. Why? The range dampens the volatility in effective Fed funds. How do you measure standard deviation in a range? You don’t.
Let’s also look at curve steepness. Again, from the Trader’s Narrative blog:
- 1992: The Fed started tightening in early 1994 (from 3% to 5.75%)
- 2003: The Fed waited until June 2004 to start tightening (from 2% to 6.25%)
- 2010: With the steepest yield curve on the records, the Fed continues to stand aside.
Now lets look at a chart I modified from the blog. The ratio of 5yr yields over 2 yr yields:
These have been secular trends in rates that have taken place across a good part of our lifetimes (for some of us, anyway). On one hand we see easings in monetary policy becoming more dramatic while the steepness in the yield curve has had to be juiced. Meanwhile, we’ve had a fantastic bull market in money supply growth:
On top of that, we had the lending facilities and MBS purchases and swap lines with other central banks. What will the Fed do the next time an easing is needed? Whatever it is, the response will have to be stronger and possibly more unorthodox – more unconventional – than it was before. People in Austin, TX like to say “Keep Austin Weird” and that’s fine. They can keep their weirdness. I sure as hell don’t like seeing my central bank engage in it, however…
So while folks have cheered charts like this:
I’ve also been keeping the first three charts in mind while I look at these:
The recovery that took place during the Bush years basically just took us past to the previous peak in Durable Goods while the Real Retail and Food Services Sales chart pretty much went along almost uninterrupted. But the pullback this time around has been significant.
Which leads me to these three charts I saw in Edward Harrison’s excellent Credit Writedowns blog post “Albert Edwards: Global economy to roll over in six to nine months’ time; bearish for shares:”
What I see in these charts as well as the year-over-year charts is that V-shape which so many folks have wanted to crow about. Ok, fine. But consider the levels for a moment and all you see is that all the money we’ve thrown at the economy was to stop the complete implosion of credit. When looked at on a levels basis you can see there’s a long, long slog ahead of us.
But what I wonder is this: are we in for more volatility in economic indicators as Fed monetary policy response looks more and more like a” Twilight Zone” episode and less like central banking? And with what effect? What if all this stimulus, all this unorthodoxy in central banking does is – as a best case scenario – get us back to our last cyclical peaks in 2007? We would’ve replicated Japan. Richard Koo would be trying to convince us that was a good thing while I look at him like he is a three-headed cyclops. The image of a three-headed person just wouldn’t capture my level of bizarreness well enough.
So this oscillating macro scenario is something I’m trying to come to terms with. It seems like there could be plenty of cycles of recovery and recession as we go forward, but only because the data becomes more volatile (go look at the volatility in the economic time series data back in the ’70s to get a feel for this) while fiscal and monetary policy responses from government become more and more statist; more and more atypical of what this country is used to and what it was founded upon. Also, with higher volatility, I figure the cycles will shorten. So instead of the normal cycle where recoveries take 6-8 years and recessions are 2-3, the volatility will shorten these cycles. Less Lexapro, more Lithium as the economy goes from being moody to bipolar. All the while we float between support and resistance, making little progress in advancing through past cyclical peaks.
But it does make sense to me, strangely enough. Why? Simple. We haven’t had a truly Earth-shattering breakthrough since some students at the NCSA started using something called HTML to design these things called web pages and Marc Andreessen ran with the idea and developed this company called Netscape. Yes, we have Twitter. Yes, we have Facebook and yes, dear God, we even have MySpace. But we still point and click our way around a two-dimensional GUI, most likely running on a 32-bit (although 64 bit is gaining) Intel-based chipset that has been essentially unchanged for decades. Yes folks, I’m saying we have plateaued in terms of innovation.
Green tech? Current technology in that space is merely a tradeoff of contentions: clean energy produced with a minimum of toxic spillover, but yields are lower and it takes more time – the most valuable resource – to produce. All while more is demanded because the population is expanding. Yet another area we need a breakthrough.
But with government doing everything it can to encourage spending/consumption, there is no savings to invest. No investment, no breakthrough discoveries. No discoveries, our standard of living does not improve. We simply reach a level of stasis and stay there – like Japan has.
Or if you prefer, like stagnant pondwater…
And what if we have something less than our best case? Well, there’s this: