The Market Reminds the Fed to Keep the Easy Money Flowing
By Dr. Duru written for One-Twenty
June 22, 2009
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Back when Alan Greenspan was giving away money on the cheap during and after the last recession, it seemed like the stock market would sell off going into every Federal Reserve meeting. It was as if the market wanted to remind the Fed to keep the easy money flowing. Of course, the market would get its drug, uh, wish, and proceed to launch into another short-lived bear market rally. I daresay the market has resorted to the same tactic over the past week in the wake of all the G8's talk about exit strategies from existing stimulus measures. The stock market's changing character that has driven the S&P 500 back below 900 and challenging critical support levels will certainly wake up a few people in this week's Federal Reserve meeting. Sure this one week of selling has barely dented the big move from the March lows, but it will take complacency down a notch. It is all too easy to assume that a rallying stock market means a rallying economy is ahead and forget that the market predicts about 5 out of every 3 recoveries just as it predicts 9 out of every 5 recessions.
On June 13, 2009, the G8 Finance Ministers tried to remind the world that easy money will not and cannot flow indefinitely: "We discussed the need to prepare appropriate strategies for unwinding the extraordinary policy measures taken to respond to the crisis once the recovery is assured. These 'exit strategies', which may vary from country to country, are essential to promote a sustainable recovery over the long term. We asked the IMF to undertake the necessary analytical work to assist us with this process." The recognition that the exit plan will vary from country to country was key because Treasury Secretary Tim Geithner made it abundantly clear that the U.S. is nowhere near the point of exit. In fact, the exit signs are not even lit yet: "...It’s too early to shift toward policy restraint" (from Bloomberg). (Please no one yell inflation in a bank vault full of freshly minted greenbacks!). With unemployment continuing to rise, and the Federal Reserve's own forecasts showing double-digit unemployment next year and a weak economy through at least 2010, Geithner's balking is quite understandable. Indeed, I continue to argue that the Federal Reserve will be loathe to tighten monetary policy even one basis point and thus subject itself to the intense pressure from politicians and business leaders who will cry foul. They will all accuse the Fed of squelching the recovery before it gets started. With the fears of delfation and Depression fresh on the brain, the Fed will continue to choose inflation over a deepening (or double-dip) recession (assuming it has a choice of course).
Apparently, the talk of exit strategies originated from the IMF, the organization charged with helping the G8 with exit analyses. In a March, 2009 paper called "The State of Public Finances: Outlook and Medium-Term Policies After the 2008 Crisis", the IMF sounds the alarm about growing public debt levels across the globe. The IMF urges governments to provide clarity and transparency as soon as possible about how they intend to deal with this threat to the health of the global economy. They provide four key recommendations recognizing "while these prescriptions are not new, the weaker state of public finances has dramatically raised the cost of inaction":
- Fiscal stimulus packages, where these are appropriate, should not have permanent effects on deficits
- Medium-term frameworks, buttressed by clearly identified policies and supportive institutional arrangements, should provide a commitment to fiscal correction, once economic conditions improve
- Structural reforms should be implemented to enhance growth
- Countries facing demographic pressures should firmly commit to clear strategies for health and pension reforms.
Thus, we have a very serious tension building in the global economy: financial systems (especially global stock markets) that will remain highly dependent on stimulative policies and easy money for some time to come versus the declining quality of the very balance sheets used to support and fund these accommodative activities. This is a situation that has a better than 50/50 chance of providing a catalyst for the major correction I continue to anticipate in the Fall. (Note well that Russia's stock market has already experienced a "significant correction - just this month, it is down 20% from its recent peak).
Be careful out there!
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