Why the US Federal Reserve Is Creating A New Narrative

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If you haven’t already done so, make sure you sign up for Kris Sayce’s latest project. For a start, it’s free…it will only cost you your time and consideration. Second, the idea that Kris is talking about is potentially very lucrative. It’s a ‘megatrend’…one for the super fund or the proverbial bottom drawer. To find out more, click here.

The general consensus is that stocks (doesn’t matter which ones, pick anything) are in a megatrend too. The Dow breached 17,000 points overnight, which is neither here nor there, but the media loves it. They’ll soon latch onto the significance of the S&P 500 crossing 2,000 points. That’s a mere 15 points, or one or two trading sessions, away.

But can’t stocks go down? Not anymore by the look of things. And certainly not according to this article, which boldly claims that ‘the SPY (S&P500) is NOT extended and may NEVER pull back’. Gee, you better get in and buy then…

Strong employment data released overnight was the reason for the latest US stock market surge. By the way, the employment data came out a day early this month because the US celebrates Independence Day tomorrow. Oh what the Founding Fathers would say about their great republic! A constitution flushed down the toilet…the dollar beaten relentlessly around the ears for a century…Congress a cesspit of deceit and corruption. How proud they would be!

But I don’t mean to be a party-pooper. Happy Birthday United States, get stuck into it…

Anyway, the US economy created 288,000 jobs in June, with upward revisions made to the May data. The labour force is undoubtedly strengthening. The unemployment rate dropped to 6.1%, the lowest rate since September 2008, which, incidentally, was before it all went pear-shaped.

A few months ago, the markets would have taken this good news as bad news. But recent speeches by US Federal Reserve chief Janet Yellen have convinced the punters that economic and labour market strength won’t be a barrier to keeping interest rates low. It’s the best of every world there is…and apparently this scenario isn’t priced in!

What’s incredible about all this is the psychological angle. I’m reading an increasing number of articles justifying this high price/low interest rate environment, and why it will persist forevermore.

Bill Gross, head of bond fund PIMCO, made a heroic effort to do this recently…probably because his bond fund has been bleeding money for a while now. He’s pitching the ‘New Neutral’ idea (because the ‘New Normal’ idea he previously pitched didn’t really fit in with a relentless bull market).

The New Neutral is an environment where real interest rates are closer to 0%, rather than the previously thought 2% advocated by John Taylor of the ‘Taylor Rule’. In the New Neutral, the Federal Reserve can maintain this status quo, stocks will advance and the economy will hum along in a goldilocks fashion (yes, he said goldilocks) without inflation ever becoming a problem.

He’s not a raging crazy bull though. That wouldn’t befit a bond fund manager. In fact, it would be bad for business. Here’s how he sees it:

‘But to the point – if The New Neutral is closer to 0% than 2% – if Taylor is replaced by PIMCO’s New Neutral – then risk assets, even without QE checks, can stand on their own two legs. They won’t be stilts, more like peg-legs in a historical context, but stable nonetheless. We expect bonds to return 3-4% over the next 5 years and stocks perhaps 4-5%. If central banks proceed cautiously, there’s no need for another Lehman Brothers, but as well, there will be no interest rate propellant for double-digit asset returns. Those days are gone. The journey to 0% nominal Fed Funds and a negative 1½% real rate is over. A 0% real Fed Funds New Neutral lies ahead, a tightening of credit yes, but a mild one to be sure.’

I don’t know if Gross is right or not. That’s not the point. The point is that Gross represents the views of the big money oligarchs, and the new narrative of these oligarchs is that the Federal Reserve will tighten, but not by too much…and the bull market will roll on.

A few weeks ago I wrote of the need for investors to create narratives, or stories, about the market to give them some sense of comfort and understanding about what is going on. The truth is that no one really knows what’s happening, the world is random and unpredictable…yet we try to understand.

I also wrote that ‘If we believed that the world is truly random and unpredictable, and chaotic and cruel, we’d be in a state of anarchy.’

A mate of mine, who is a long time reader of The Daily Reckoning, picked me up on this, and rightly so. Take it away Scotty…

Anarchy — correctly defined — is simply a stateless society; a situation where no ‘body’ or organisation holds ultimate power over individuals within the society. Self-organisation (or self rule) is the result of anarchy. The idea that a stateless society would see us descend into chaos is a furphy.

Furthermore, if one considers that most of the ills of society are caused as a direct or indirect result of the actions of the State, I would suggest to you that a descent into anarchy cannot come quick enough. Anarchy should be the goal of all individuals in the interests of us all living truly free and prosperous lives.

‘Anarchy is everywhere. Without anarchy as the default state, the whole world would disintegrate. Not only is all human progress due to it, but so too is the entire evolution of the ‘natural’ environment. All order extends from anarchy. All things that rise above the state of nature are owed to it. When humans truly thrive, it is only because of a lack of controls, not because of controls. If any of us wishes to live in a more beautiful society we should each strive to reduce the controls in our lives.

It’s a paradox that must forever be explained.

With this in mind, it’s obvious why central banks and governments are so keen on keeping the party going. It’s not to create employment or keep inflation low. It’s to maintain power and control. To keep us subservient to the new class of financial oligarchs. Without our belief, they are nothing.

Bill Gross is one such oligarch, whether the old hippy likes it or not. The narratives spun by his type are designed to keep the masses in the game and invested in the status quo. As markets change, so do the opinions of these elites. That’s why ‘markets make opinions’, which is an adage as old as Wall Street.

And this is exactly what you’re seeing now. People are creating a narrative to justify why the market has gone batsh*t crazy…in the same way they did in 1999 to justify investing in stupid internet stocks, and the same way they did in 2007 to justify investing in anything.

It’s always the same…but different. One of my favourite credit analysts, Doug Nolan (whom I quote regularly), nails this same but different issue. He reckons that the less conspicuous the bubble, the more systemically dangerous it is. He digs into the plumbing of the system to show how asset and credit inflation is running out of control, while those above only see the taps flowing smoothly…for now. Says Doug:

As part of my Bubble analysis framework, I have posited that the more conspicuous a Bubble the less likely it is to be systemic. The “tech” Bubble was conspicuous, though gross excesses impacted only a relatively narrow segment of asset prices and a subsection of the real economy.

I received a lot of pushback to my mortgage finance Bubble thesis during that Bubble period. The conventional view held that excesses were not a major issue, especially when compared to the Internet stocks and all the nonsense illuminated with the technology Bubble collapse. The Fed’s unwillingness to move beyond baby-step rate increases (to aggressively tighten Credit) played prominently in Bubble Dynamics. Today, conventional thinking sees a system that has been working successfully through a multi-year deleveraging process. Leverage and speculative excess are believed to be nothing on the order of those that gave rise to the (“100-year flood”) “Lehman crisis.”

But they are. They are much worse. And only hindsight will reveal the extent of the excess.


Greg Canavan
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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3 Comments on "Why the US Federal Reserve Is Creating A New Narrative"

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slewie the pi-rat
slewie the pi-rat
2 years 3 months ago

anarchy doesn’t mean there are no rules, does it?
i think it is more about: no ruler.
my thinking in this area is tethered to the “idea” that
higher mammals have the capacity for play.
play is anarchistic, at least until someone loses a tooth or an eye.

is “boilerplate” the polar opposite of “anarchy”?

maybe some day, when we lose a loved one, we’ll hear someone intone:
“anarchy to anarchy; boilerplate to boilerplate.”

2 years 3 months ago

Slew, I always thought anarchy could only be a very temporary state. Hasn’t stopped those purveyors of utopias from mesmerising their true believers with it. We only need to kill another million people and we’ll arrive at universal peace and harmony dontchaknow.

2 years 3 months ago

Energy makes money, money does not make energy.
Peak oil mates, peak oil. Depopulate or perish.

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