When European interest rates descended towards zero in 2014 and lenders hawked their wares, Dire Straits' "Money For Nothing" repeatedly ran through my head. Now as rates have perversely dived below ground level, European borrowers have replied like a character in Kipling's Captains Courageous with "You Couldn't Pay Me!" as they anticipate that deflation will make their investments worth less later than they are now. Frankly, my head is a little woozy as I attempt to understand negative rates and their impact on future cash flow expectations. Does this mean that at some point we will lend $110 to receive $100 in the future? Maybe this is the time when gold is good? Bitcoins? In the equity world, less is bad, and I often describe how you can't value a melting ice cube because its utility declines as time passes. Maybe Al Gore was right. Global warming has taken over.
Lower for Longer
Or The End of Patience? I couldn't decide. In either case, slower economic growth has conspired with lower inflation both abroad and at home to push the Fed to delay their highly anticipated rise in short-term interest rates. According to RenMac, as of mid-April, 65% of Fed watchers anticipate a rise in September, while just 18% believe it will start in June. Personally, I think shrinking the balance sheet by letting their bonds mature is a better compromise and a natural transition from tapering. Equities - which seem to revel in every permutation in Fed policy or economic growth - have risen to a high water mark. Europe and small caps have led the charge as many large cap and dividend payers have suffered due to the dollar's strong advance and the collapse in energy prices. In contrast to rising stock prices, earnings for the S&P 500 are now expected to decline for 2015. Despite the obvious rise in P/E, bulls remain right in their case for Tina ("There is no alternative") as the U.S. 10-year Treasury yield at 1.93% represents little competition.
We Need Less Cowbell
I have felt this way for a while. Fed policy, while imperfect, has successfully navigated the credit crunch of 2008 to 2009, the slow subsequent economic advance and has had little bubble effect six years into the bull market. My fear is that continued easing will lessen the Fed's ability and flexibility when they really need monetary ammo. Additionally, as debt represents future growth borrowed, I think a smaller Fed balance sheet - meaning less debt - really means greater growth later. Doves claim that full recovery labor gains have been weak and there has potentially been a permanent loss in a portion of the labor force. While true, signs of a labor tipping point are emerging. Both Wal-Mart and McDonald's have recently lifted wages to workers and the unemployment rate has held at 5.5% in March, the lowest level since May 2008. Moreover, the four-week rolling average of first-time unemployment claims has reached the lowest level since 2000. Now below 300,000 for five consecutive weeks, the labor market is truly strengthening.
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