CIO Markets Report • Key Observations • Implications • Markets Charts
Key Observations and Implications
1. The Fed and Punchbowls. When the worst financial crisis since the Great Depression hit the U.S. in late 2008, the Fed lowered rates to near zero, implemented quantitative easing (QE), and acted as lender of last resort. This was labeled unconventional monetary policy and continued for seven years, until 2016. Then, in early 2020, the first global pandemic in 100 years unfolded worldwide. Lockdown economics and virus avoidance behaviors led to a sudden stop in economic activity, with U.S. GDP falling at an annual rate of 31% in 2020 Q2, the largest drop ever. In response, the Fed applied the same trio of near-zero interest rates, more QE, and lender-of-last-resort policies. The results: both recessions were contained, short-term interest rates have been held to near zero for nine of the past thirteen years, and the Fed’s balance sheet has increased from $0.9 trillion to $7.7 trillion (Chart 1). After over a decade of unconventional monetary policy, the Fed is not done yet. Recent comments by San Francisco Fed President Mary Daly (“We won’t be preemptively taking the punchbowl away.”) and guidance from the May FOMC meeting—that short-term interest rates will continue to be held between 0.0% and 0.25% and the Fed’s balance sheet will continue to increase by $120 billion per month ($1.44 trillion per year)—make this clear.
2. The $5.5 Trillion Dollar Drop (26% of GDP). Since March 2020, the Federal government has implemented three rounds of stimulus spending to confront the pandemic, transfering $5.5 trillion directly to households and state and local governments. The scale of these transfers and the total scale of government spending is only matched by the wartime spending of the 1940s (Charts 2 and 3). The dollar drops were financed with government debt, mostly absorbed by the Fed (Chart 4). The early evidence is that 30%, or $1.5 trillion dollars, is being spent on goods and services, while 70% is being used to pay down debt and for savings and investment, including the now-famous “stimmy” day traders and reddit/r/wallstreetbets investors (Charts 5-7). Dollars of this magnitude suddenly cascading through the economy and markets have had an outsized effect on all asset prices, from used cars to stocks (Charts 8–13).
3. Unconventional Monetary Policy = Unconventional Asset Prices. The Fed has updated its Monetary Policy Stategy to achieve its mandate of “maximum employment, stable prices, and moderate long-term interest rates.” For price stability, the Fed will aim for average inflation of 2%. For employment, the Fed now looks to employment “shortfalls” by subgroups in the labor force. This allows the Fed to let the total economy “run hot,” with short-term inflation above 2% until employment goals are met. One hotly-debated issue is that the Fed’s measure of inflation does not include asset prices, especially housing prices. For housing costs (index weight of 27%), the Fed computes Owners’ Equivalent Rent to capture the cost of acquiring shelter, whether renting or buying. As long as the Fed’s measure of inflation stays contained, the Fed does not need to “take the punchbowl away.” Yet many economists and analysts link excessive moves in asset prices to Fed policy. For housing, interest rates are at or near all-time lows, personal income is up when transfer payments are included, jobs in many parts of the economy are booming, and household wealth is at an all-time high. So is the demand for homes. On the supply side, there are multi-year supply shortages of land, trained labor, and materials such as wood and glass. The result: the housing boom (Charts 14 and 15).
Implications. Inflation is here, and it’s in asset prices. The Fed will continue its accommodative policies. But the Herbert Stein rule still prevails: if something cannot go on forever, it will stop. Therefore, liquidity, diversification, and investment costs are what matter most. 2 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 1
“You're right, we [the Fed] did it. We're very sorry. But thanks to you, we won't do it again.”1
And in 2008 and 2020 they didn’t
The Fed and 1-month government interest rates in April 2021: 0.0076% The Fed's balance sheet in April 2021: $7.7 trillion Near-zero rates for 9 of past 13 years Mostly U.S. government debt and government guaranteed mortgages
1 Ben Bernanke, then Vice Chairman of the Fed, at a November 2002 gathering of economists at the University of Chicago celebrating Milton’s Friedman’s 90th birthday. Bernanke gave a talk honoring the work Milton Friedman and Anna Swartz did on the pivotal role of central bank monetary policy in an economic crisis. They showed that Fed policy from 1929 through 1937 contributed to making the Great Depression deeper and longer by removing liquidity from the banking system and raising interest rates during the crisis. At the end of a talk tailored to economists, he summarized it in clear words that all of us can understand: “I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we [The Fed] did it. We're very sorry. But thanks to you, we won't do it again.”
3 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 2 U.S. Government Transfers to Individuals and State and Local Governments as a % of GDP, 1929 - 2020
20%
15%
10%
5%
0%
Source: U.S. Bureau of Economic Analysis, Tables 1.1.5 and 3.2 Note: total payments actually sent in 2020 totaled $4.4 billion, the balance of the $5.5 trillion approved is being sent in 2012 Q1.
4 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 3
U.S. Government Current Expenditures as a % of GDP, 1929 - 2020
35%
30%
25%
20%
15%
10%
5%
0%
Source: U.S. Bureau of Economic Analysis, Tables 1.1.5 and 3.2
5 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 4
QE-3: Sept 2012 QE-4: Dec 2012
QE-2 Nov 2010-June 2011
QE-1 Dec 2008 - Mar 2010
"normalization" U.S. unemployment rate falls to 3.5% by Feb 2020 Fed Vice Chair Bernanke: "we won't do it again," and "Helicopter Ben" March 2020, Federal Reserve November 2002 announces extensive new measures to support the economy
Greenspan Bernanke Yellen Powell 6 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 5
7 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 6
8 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 7
9 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021
Chart 8
10 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 9
Hot Roll Steel: goes everywhere, from autos, to homes, to office buildings
11 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 10
12 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 11 Tesla (TSLA), up 800 percent
Source: Bloomberg
13 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 12 GameStop (GME), of reddit/r/wallstreetbets fame
Source: Bloomberg
14 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 13 ViacomCBS (VIAC): Liquidity and Leverage
Source: Bloomberg 15 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 14 “The Panic Ignited a Housing Boom”
Personal Income up, Ultra-Low Interest Rates = Demand Up
Land and Material Costs up, Labor shortages, Regulation up = Supply Down = “The residential real estate market is on its biggest tear since 20061”
Housing Supply in Months
Source: National Association of Realtors; U.S. Department of Labor Source: National Association of Realtors; Federal Reserve Bank, Kansas City Data is adjusteed for inflation and at a seasonally adjusted annual rate
1.Wall Street Journal, The Panic Ignited a Housing Boom, 3 April 2021
16 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021 Chart 15
17 Stephen Sexauer, CIO Tom Williams, Deputy CIO CIO Markets Report April 2021