What I love about sports is that everything is black and white. You can't pretend to be something that you are not. You win or lose based on your abilities and performance. When it comes to team sports it is the star of the team who usually garners most of the attention. Yet a team is only as good as its weakest link, so members of the very best teams work together seamlessly to support each other in a way that optimizes the team's overall performance.
Coaches play a critical role in this capacity because they develop the strengths, neutralize the weaknesses, assign players to certain positions and formulate a strategy that achieves success. Ron Rivera and the Carolina Panthers embody this success to perfection, as their 15-1 record and Super Bowl appearance clearly shows. If unsuccessful in this endeavor, then the team loses and the coach is ultimately dismissed for a new one. That's as black and white as it gets.
I wish the global game of central banking operated in the same way as professional sports. Sadly, it does not, despite the fact that both operate on the basis of economics. In the spirit of Super Bowl 50, here is an update on the performance of our central bank coaching staff and its stewardship of team USA, otherwise known as the US economy.
It is nearing the end of the fourth quarter in an economic expansion that is losing strength by the day as the incoming data routinely falls below consensus estimates and the year-over-year comparisons continue to weaken. Even the coaching staff's star player, the US stock market (NYSEARCA:SPY), is starting to fatigue. There are only three plays left to run in an effort to turn this expansion around, with two of them being suboptimal at this point.
A move in the direction of negative interest rates, as central bankers in Japan and Europe have employed, is off the table for now, considering that the Fed just raised interest rates this past December. The possibility of additional quantitative easing seems equally as remote, and would likely be ineffective, considering that there are still $2.5 trillion in excess reserves in the financial system and long-term interest rates have already fallen significantly since the Fed raised interest rates in December. The only play left is more forward guidance, which is the same play that the Fed has been running over and over again since the beginning of this year. Regardless, the Fed ran this play three more times this past week to no avail.
Coach Yellen sent in her first-string quarterback on Monday morning for the first down. Fed Vice Chairman Stanley Fischer gave a speech in which he suggested that recent financial market volatility could lead to a tightening of financial conditions that might impede economic growth in the US. At the same time, he suggested that prior periods of market volatility had not impeded US growth, so it was still too early to tell if the recent volatility would delay another interest-rate increase at the Fed's March meeting. Some viewed his comments as dovish, reducing the chance of a rate hike in March, which briefly reinvigorated the stock market on that day, but his lack of clarity created just as much uncertainty, and stock prices declined on the following day. In other words, he threw a Hail Mary pass, but none of his receivers ran down field to catch the ball because they were all too confused by the audible he called on the play.
Coach Yellen sent in her second-string quarterback on Wednesday for second down. Fed Bank of New York President William Dudley gave a speech in which he said that financial conditions had tightened considerably since the Fed raised interest rates in December, markedly reducing the likelihood of an additional interest-rate increase in March. His forthrightness sent the stock market modestly higher, recouping losses from earlier in the day, but ultimately finished unchanged. In other words, he completed a lateral pass, but there was no gain in yards on the play.
Working her way down the bench, Yellen sent in her third-string quarterback on Thursday for third down. Cleveland Fed President Loretta Mester decided to run the ball straight down the middle when speaking at a conference in New York. She dismissed recent financial market turbulence, claiming that "solid" jobs and income growth "suggest that underlying US economic fundamentals remain sound." She implied that the Fed would move forward with its planned interest-rate increases for 2016 as a result. This play was over as soon as the ball was snapped. Mester was summarily sacked behind the line of scrimmage, and there were multiple flags thrown on the play by the officials for what was called intentional bullshitting. My apologies for the vulgarity, but this is the NFL!
Now it's fourth and ten with time running out, but the problems for the Fed run deeper than calling horrible plays. The overall strategy has been ineffective for a very long time. It has focused all of its efforts on the performance of its star player, the stock market, at the expense of the other members of the team. As a result, our weakest link, which is the middle class, has continued to weaken. Now the stellar performance of the star player is starting to fade, because the performance-enhancing drugs that the coaching staff has been administering for years have worn off.
Buying US government bonds to lower long-term interest rates and increase the supply of money in the financial system (quantitative easing), in combination with lowering short-term interest rates to zero, undoubtedly creates a wealth effect. That was the successful part of the strategy. Yet the wealth effect doesn't work for the whole team unless that wealth is distributed broadly enough so that it is spent. Even if it had been more broadly distributed, anything that isn't perceived to be permanent only has a temporary effect.
Every time Washington introduced a consumption-based stimulus program to buy houses, cars or appliances we saw a spike in economic activity. Still, the increase in purchase activity was simply stealing forward demand that would have occurred on its own otherwise. So a lull in economic activity would always follow when the stimulus ended.
The Fed's stimulus policies were no different. They enticed the wealthy to consume, or invest in, higher-risk financial assets. Now the stimulus has ended and we are seeing a decline in financial asset values. The Fed also used lower interest rates to entice consumers to make debt-induced purchases, but these were purchases that would have been made anyway. No one buys a house or a car because of the interest rate. The interest rate may affect the timing of the purchase, but not the purchase itself.
We are now experiencing a significant lull in economic activity, while at the same time the demand for higher-risk financial assets is fading. The combination spells trouble, because these two developments are now feeding on each other, and likely to hasten and worsen the decline.
Janet Yellen is no Ron Rivera, and the US economy's performance is far from that of the Carolina Panthers. To the contrary, if the US economy were a professional sports team, Yellen and her coaching staff would have been fired a long time ago. Not only is the Fed not Super Bowl worthy, they wouldn't have even made the playoffs. Their strategy hasn't worked in the US, it never worked in Japan and it isn't working in the European Union. Instead of being a strategy, it is more of a broken ideology that boils down to nothing more than shifting around the supply and demand for goods, services and financial assets. Hopefully a losing season in 2016 will lead to a new game plan with a different strategy that put the US economy and stock market back on track.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.