US government is already running on fumes

Outlook:

We get the minutes of the September FOMC at 2 pm today. The WSJ headline is “Global Stocks Edge Lower as Investors Await Fed Minutes.” What nonsense--we will not get one scrap of useful new information or insight. If the Fed was concerned about global develop-ments, what can have changed in just a few weeks to induce observers to think that factor is off the ta-ble?

As for stabilizing equity markets—the Fed can’t take credit for that. The bottom (1868 in S&P) was al-ready in when the Fed delivered the verdict of delay, and tested the low afterwards (1884). It’s hard not to conclude that the Fed added to volatility instead of tamping it down. And we see the same thing in fixed income. Nobody really thinks the yield has steadied at 2%+. We might be prepared for the Oct FOMC to bring another delay, but delay at the December meeting is already widely expected, too. The Fed has nobody to blame but itself. The market would have accepted normalization as a suffi-cient reason to do the First Rate Hike even in the absence of inflation or rising inflation expectations.

The Fed might look to the Bank of England for guidance on how to do it right. The BoE said that despite an oddly high labor cost rise in August, in general those costs are not going to deliver inflation over 1% until mid-2016. And “Policymakers were fairly relaxed about overseas developments, saying there was little evidence so far that a slowdown in emerging markets was having much impact on advanced econo-mies.” We are left with the same degree of uncertainty about the timing of the UK’s first rate hike, but we are given specific data to drive expectations and a data-based judgment about the EM slowdown ef-fect.

The Fed needs to get over itself, as they say on TV. A marginally higher interest rate has very little ef-fect on businesses and in fact might bring a tiny advantage to savers. The Fed seems to have missed the baby boomers retiring at a rate of 10,000 per day and these are the segment of the population that appre-ciates higher low-risk returns. When return is near zero for low risk savings, the Fed is pushing retirees into the equity bubble, junk bonds and other iffy things.

A tidbit about consumer behavior feeds into the bad attitude—something named the JP Morgan Chase Institute combed through spending data and discovered that 80% of the savings from lower gasoline prices is being spent on restaurant meals and other frivolities instead of being saved (the top categories are “services” and “non-durables’). According to the FT, people say they are paying down debt and sav-ing, but actual behavior shows otherwise. To be fair, energy savings are only about 5% of total disposa-ble income, but still, when energy prices go back up, they will pull back this spending proportionately. If there were a decent return on savings over the marginal utility of instant gratification, maybe they would be saving instead of spending.

Besides, a development more important than the Fed’s indecision is the US government running out of money and Congress not willing to pass a new funding bill. In fact, the government is already running on fumes and will be in dire shape on Nov 5, when it does actually run out of money. The departing Speaker says he wants to “clean the barn” before he goes, but these guys are criminally irresponsible. The FT notes that “So far investors are not pricing in any chance of the US government being forced to default on its debts. An auction of 10-year Treasuries went well on Wednesday, with the US government issuing the benchmark bonds at an average yield of 2.066 per cent, slightly above where they were trad-ing ahead of the sale.”

But it remains a risk and not a trivial one. Goldman is not worried, but JP Morgan is worried. Traders have already re-jiggered maturities so as to have nothing falling due the first week of November. The FT reports “But some analysts worry that the presidential election cycle and the Republican changing of the guard deepens the air of unpredictability swirling around the US capitol, and fear that distracted markets are overly sanguine at the modest but real risk of a debacle. Analysts at Guggenheim Partners estimate there is as much as a 25 per cent chance of ‘some kind of accident that would keep Congress from rais-ing the debt ceiling in time due to brinkmanship, procrastination or political gridlock’. Those odds will rise closer to the deadline, the asset manager warned.”

Quick, find a reason to buy dollars. Probably the only reason out there is relative growth, assuming the US can weather the coming emerging market crisis. The OCED, which competes unsuccessfully for prominence with the IMF, has a monthly leading indicator. It shows generally falling growth, although the eurozone is “firming up” in places like France and Italy. The eurozone gets a reading of 100.7. India gets a higher reading, too. China, of course, is slipping, along with Brazil and Russia. The US in-dex is 99.2 from 99.5. Never mind—the UK and Japan both slipped back, too.

Here we go again—slower growth, a reduced probability of inflation, central banks in easing mode. This is Summers’ secular stagnation, and right on time, Summers appears again on the front page of the FT to say forget about structural reform, governments should engage in massive fiscal stimulus. He makes a compelling argument for a vicious cycle coming from the drop in emerging markets contaminating de-veloped countries which have no further easing to embrace. We hate to admit it because Summers is an obnoxious boor, but he’s right. He says “If I am wrong about expansionary fiscal policy, the risks are that inflation will accelerate too rapidly, economies will overheat and too much capital will flow to de-veloping countries. These outcomes seem remote. But even if they materialise, standard approaches can be used to combat them.

“If I am right and policy proceeds along the current path, the risk is that the global economy will fall into a trap not unlike the one Japan has been in for 25 years where growth stagnates but little can be done to fix it. It is an irony of today’s secular stagnation that what is conventionally regarded as imprudent of-fers the only prudent way forward.”

Try selling that in Washington.

That leaves a crisis as the only reason to buy the dollar as a safe-haven. Bullets getting fired in the South China Sea, maybe. Some major EM having a nervous breakdown (not China). But before any of those apocalyptic events might occur, we are more likely to get a rise in commodity prices that looks sustaina-ble, at least for a while. This would give some justification for a Fed hike, if not in the next 90 days. We just can’t find any reasons to like US assets or the dollar.