When Fed Policy and Market Expectations Collide

Posted On Mar 4, 2016 By Dave Gonigam

  • The number that makes a March rate increase a certainty…
  • … and why it will set off the next “mini-crash”
  • Startups stumble… but is “Tinder for dogs” a viable business model anyway?
  • The Saudi Arabian revolt Western media aren’t reporting
  • Why people will cheer even if a President Trump screws up… more reader comment on our editors’ recent performance… a “professional” weighs in on our great North American beer debate… and more!

That’s it. A March interest rate increase is in the bag — no matter what chatter you hear elsewhere.

In 12 more days, the Federal Reserve’s Open Market Committee will issue another “policy statement.” If you’ve been reading regularly, you know Jim Rickards has stuck his neck out in recent weeks — expecting the FOMC to raise its benchmark fed funds rate.

This has been an outlier forecast. The Wall Street consensus is that the economic numbers of late have been too weak to justify a follow-up increase to the one the Fed made in December. Another increase would only make matters worse.

Which it would, but that’s beside the point… Heh…

The last “major” number to come before the Fed meeting is out this morning — the February jobs report.

The wonks at the Bureau of Labor Statistics conjured 242,000 new jobs for the month — way more than the “expert consensus” was counting on. The U-3 unemployment rate held steady at 4.9%.

The number that Fed chair Janet Yellen keys on showed improvement: The labor force participation rate — the percentage of working-age adults who have a job or are looking for one — has moved up to 62.9%, the strongest reading in more than a year.

The one downer is average hourly earnings — which ticked down 0.1%, but that’s after strong improvement the month before.

Even the real-world unemployment rate from Shadow Government Statistics — measuring U-3 unemployment the way it was during the Carter administration — is back to 2012 levels, at 22.8%.

Pockets of the mainstream are slowly coming around to Jim’s way of thinking: “Payroll gains are unquestionably impressive,” says a summary from Econoday, “and today’s report will very likely revive at least the chance for a rate hike at this month’s FOMC.”

Here’s the problem. “The market does not expect a rate hike in March,” says Jim Rickards.

Indeed, it does not. Even with the new jobs numbers in play, the futures market for the fed funds rate (yes, such a thing exists) indicates there’s only a 2% probability of a rate increase later this month. (Update at virtual press time: It’s now 0%!)

Something’s gotta give. “There are only three possible outcomes,” Jim says.

The first is that traders adjust their expectations over the next 12 days.

The second is that Yellen issues some sort of signal the Fed won’t raise rates. As a practical matter, that would have to happen today or Monday because there’s a “blackout period” of one week before FOMC meetings in which Fed pooh-bahs can’t give speeches or interviews.

“The third possible outcome is a train wreck that will roil markets,” says Jim. “Right now a train wreck looks like the most likely outcome.”

Jim has an analogy in mind — an actual train wreck. In April 1900, a railroad engineer named Casey Jones was behind schedule on a passenger run from Memphis to Canton, Mississippi. He ran the train, the Cannonball Express, as fast as he could — too fast to avoid smashing into another train whose cars were blocking the main line.

Jones was killed… but no one else. “Jones was regarded as a hero,” says Jim, “because he refused to abandon the train and did everything possible to slow his speed just before the collision. He died with one hand still gripping the brake handle and the other hand on the train’s whistle.

“Janet Yellen and the Federal Reserve are now driving their own Cannonball Express consisting of interest rate hikes.”

And you can think of the market’s expectations as another train on the tracks.

Still, “the Fed is moving at full throttle toward a rate hike,” Jim goes on.

The Fed has its reasons. “They wanted to avoid making asset bubbles any bigger,” says Jim. “The Fed needed to maintain its institutional credibility after promising for over a year that they would begin to raise rates in 2015.

“And just as Casey Jones did not see danger until it was too late, Yellen does not see the ongoing threat of a recession.

“If the Fed hikes rates in March when the market is not expecting it,” Jim concludes, “the rapid repricing of rate hike expectations will lead to a stock market mini-crash.”

And that mini-crash might prove to be the start of an alarming new chart formation that — in partial homage to Casey Jones — Jim’s calling “the cannonball.” You don’t want to be in the way as it hurtles down the tracks. Fortunately, Jim has a game plan to help you steer clear.

The market reaction to the jobs numbers has been muted. The major U.S. stock indexes are all in the green, but not much. The S&P 500 is five points away from the 2,000 mark.

Among the standout names is Smith & Wesson (SWHC), mentioned by Greg Guenthner in yesterday’s episode of The 5. After the closing bell, SWHC reported stellar quarterly numbers; shares are up 10% this morning.

Gold is holding onto gains notched after we went to virtual press yesterday. At last check, the bid was $1,275 — a 13-month high. And a weaker dollar accounts for only some of those gains; the dollar index is off less than a half percent, at 97.2.

Bad news on the startup beat: The big mutual fund companies are cutting way back on their investment in startups.

If you’re a longer-term reader, you know we pay keen attention to startups as an economic barometer. The Kauffman Foundation says startups — businesses less than five years old — are responsible for almost all net new jobs going back to 1980. Unfortunately the number of startups has been declining steadily that whole time.

Now comes today’s Wall Street Journal with an analysis of 40 privately held tech startups valued at $1 billion or more each, all of them with significant ownership by fund giants like BlackRock and Fidelity.

“For 13 of the startups, at least one mutual-fund firm values its investment at less than what it paid,” says the paper. “Those firms are valuing the 13 companies at an average of 28% below their original purchase price.” In addition, the funds are cutting back on new investment in startups.

“The mutual-fund pullback,” the Journal adds, “threatens to deepen a wider downturn that has already led to falling valuations, shrinking ambitions and layoffs as the receding tide of capital forces startup companies of all kinds to focus on the bottom line rather than growth at any cost.”

“The possibility that none of the current batch of startups will scale up and reward early investors with 100-fold returns is the darkest sacrilege in the Tech Faith,” wrote Charles Hugh Smith earlier this week.

Mr. Smith is one of the few unique voices in the financial blogosphere. He finds much of the “innovation” in Silicon Valley in recent years to be so much flimflam. “The core of Airbnb (and Uber et al.) is taking potentially productive assets that are currently not in the market and creating a transparent market for them: empty rooms, unused vehicles, etc.

“From what I can gather, the majority of current startups are simply derivatives of ideas that have already taken root: Tinder for dogs (no, I did not make this up), Uber for bikes, Airbnb for parking spaces, etc., in seemingly endless profusion.

“This reveals a key weakness in the boundless faith that the next Airbnb is already breathing and simply needs an injection of cash to explode on the world stage: All these ideas are consumer-based rather than production-based.

“For example, digital technologies that enable higher crop yields, lower failure rates in manufacturing, etc., have quantifiable value because they either lower the costs of production or increase productivity.”

But that’s not what the current crop of startups is delivering. It comes back to PayPal co-founder Peter Thiel’s complaint from 2011: “We wanted flying cars, instead we got 140 characters.”

Smith says it can’t end well. “If technology is no longer the source of incredible stock market valuations, then what’s left to inflate the next bubble? If the answer is ‘nothing,’ then the stock market can lose two-thirds of its value and not bounce back.”

The cannonball, again.

Now an update on one of our team’s boldest predictions of 2016 — Byron King’s call that this is the war and revolution come to Saudi Arabia.

We’re seeing no mentions in Western media, but the Twittersphere is busy reposting video clips from Arabic-language TV channels with images like these…

View to an insurrection…

With the proviso that we’re talking about random folks on Twitter… citing foreign media outlets… running images shot from mobile phones… it appears thousands of workers were protesting outside the Grand Mosque in Mecca last Sunday, angry that they haven’t been paid for the last six months.

Again, we can’t vouch for the veracity of the pictures and the claims. But we do know the Saudi Arabian government employs about 90% of the native-born workforce… and low oil prices have cratered government revenue.

To be continued…

“I think what the elite don’t get is a lot of people don’t care if Trump is a terrible president and does everything wrong,” a reader writes after yesterday’s episode.

“They want someone to go into D.C. and tear the place up, kill off half the political lifers and thumb their nose at the lobbyists.

“Everyone feels the economy, immigration policy, trade agreements etc. are spiraling downhill, and with the current D.C. cronies, they will continue to do so. With Trump, it will not be ‘business as usual.’ We may suffer in the short term, but things will change.”

“Trump may not be bribed as easily because he is self-funding his campaign,” writes another, “but the 435 members of Congress and the 100 senators are very much seeking contributions — aka bribes — from large contributors and PACs.

“Therefore, how will Trump pass some of his far-off-the-wall (pun intended) laws and regulations without the support of the other 535 voters surrounding him? Executive orders galore! So much for democracy!”

The 5: Yeah, could give new meaning to the term “imperial presidency.”

“My thoughts were exactly the same,” a reader reacts to James Howard Kunstler’s remarks we cited yesterday. “I feel that if Trump did make it to the White House, something horrible could happen to him due to the Deep State’s dislike for him.

“I well remember President John F. Kennedy. I was 13 when that happened. Then, I didn’t know anything like I do today, but reading various journals and books, it appears that a lot of evidence was swept under the rug.”

“Thanks for the reply,” writes the fellow who expressed his concerns in yesterday’s episode about the recent performance of several editors’ recommendations.

“It is always good to know someone at the other end actually reads the comments. In a lighter tone, I want you to know that I appreciate the candid, humorous and enlightening articles, letters, posts and subscriptions that I receive from Agora. Keep it up.”

“I subscribe to four or five of your publications,” says another email, “and read as much as possible of the tons of information you send out… and feel far more informed than before starting with you by ‘combining all your recommendations together’ to make investment decisions.

“Using conservative investing, I have pulled $70,000 out of my banks that paid me about $100 interest — not much — over the last year and have followed and LEARNED from your books and emails and online info.

“I have about 14 options floating with months, weeks or over a year to expiration, and have cashed in or sold about 12 of them for profits of about $5,500 so far. I give myself all the credit because I do all the other work after reading your books and recommendations constantly, and I am responsible for all that I make from your recommendations and go over them over and over with each buy or sale made.

“The easiest moneymaker so far is the Income on Demand info. Waiting for the trend of national and world markets to go down is easy based on the info you send me daily.

“Regarding your Canadian/American beer wars, my favorite drink is my morning prune juice. Just call me Mr. Excitement.”

“I’m from Wisconsin with frequent trips to Canada and Canadian friends,” a reader writes as our Canadian beer thread is finally running out of momentum. (But it sure has kept the mailbag lively this week!)

“There is no question,” he says, “that the USA comes up on the short end of the stick when it comes to the comparison in flavor and ‘kick’ of our beer versus theirs. And us Wisconsinites know our beer intimately!”

The 5: Heh… As the comedian Lewis Black once told a crowd in Milwaukee, “You are not alcoholics. You — and my hat is off — are professionals!”

Have a good weekend,

Dave Gonigam
The 5 Min. Forecast

P.S. We’ve had a lot of depressing talk about the next market crash this week.

But when the Panic of 2008 got cranked up, one fellow named Jeff followed a simple set of instructions.

By the time the collapse was done, he had DOUBLED the size of his retirement account.

He said: “I doubled my money in the greatest financial debacle of my lifetime.”

Click here to see the instructions Jeff followed.