Don’t Fight the Fed! But Come On, Really?

The old adage on Wall Street, well “old” is relative going back to maybe Allen Greenspan, is one should never “fight the Federal Reserve.” When the Fed is engaging in monetary easing strategies such as lowering interest rates or, as in the last ten years, outright purchasing of bonds and mortgage backed securities, one would be wise to hop on the Fed’s back and pile into risk-assets.

The stock market traditionally likes an accommodative Federal Reserve. Which is why Wall Street has traditionally viewed bad news as good news and good news as bad news. Bad economic news means #NiceFed?, good economic news means #MeanFed☹. So is it any mystery as to why, when jobless numbers continue to stun and frighten Main Street, Wall Street celebrates with its best week since 1974, with the S&P 500 jumping over 12%. The chart below shows the dramatic jump in jobless claims over the past three weeks. To date, the continuous jobless claims have already eclipsed the highwater mark of the “Great Financial Recession” of 2008-09.

Continued jobless claims                                                                                  

Source: Labor Department

Chart provided by Wall Street Journal

Since the economic impact from Covid-19 began showing up in Labor Department economic releases, the S&P 500 has risen over 26%. What does Wall Street see that Main Street is missing? Why does this disconnect between economic reality and stock market performance exist? Two words: Federal Reserve. Two more words: Free Money.

Since this crisis began, major Fed action has included: cutting short-term interest rates to zero, announcing plans to purchase trillions of dollars of US Treasuries and Mortgage Backed Securities, and as of yesterday announcing plans to expand its bond purchasing plan to include municipal and corporate debt. One has to wonder when will the Fed begin outright purchases of equity ETF’s. Ideas about the Federal Reserve “nationalizing” our free-market economy were once only espoused by basement-bound, tinfoil-hat-wearing conspiracy theorists. These ideas now are already in place or only a few percentage drops in the S&P 500 from being enacted.

The easy response seems always to be extraordinary times demand extraordinary action. Clearly something had to be done, right? The economy and the world have essentially been shutdown in response to Covid-19. We have no clear idea when any of this will lift, so certainly our government had to respond to protect the economy and the financial markets. Much of this is true, but the questions still need to be raised: Will the cure be worse than the disease?

Is the cure worse than the disease?

Sepsis is a condition caused by the body’s response to fight an infection. The body releases chemicals into the bloodstream to fight off this infection, leading to an imbalance which causes damage to major organs. Sepsis is a life-threatening condition. If we look at the jobless chart above, the vertical line representing the current state of affairs looks nothing like the patterns of the past. Straight lines may exist in geometry, but never in nature. The catalyst for the economic situation may have been the virus, but the unfolding of events is entirely man-made. It’s important distinction. We may be forced to accept that this virus was unleashed upon us without our consent, but we have to own up to the fact that our response is entirely consensual. A simple cost/benefit analysis should be made. It is painful to write, and I mean no offense to anyone, but the benefit of protecting hundreds of thousands may coming at the cost of burdening hundreds of millions.

Don’t get me wrong, many of the plans enacted have been vital and necessary. We need to support individuals who have lost their jobs as a result of the Covid-19 outbreak. Yet I don’t believe that we need to continually back-stop financial markets every time they begin to fall. I don’t believe our Federal Reserve should be in the business of purchasing debt obligations of individual corporations and municipalities. And I definitely don’t believe the Fed should ever consider interfering in the market by purchasing stock ETF’s. Government actions may act like a hammer and proficiently take care of a nail; but they also cause many unintended consequences and inadvertently reward one at the expense of others. In the case of yesterday’s action, some companies are being benefited by the Fed by having their borrowing costs lowered, while their competitor may not be. This creates an unlevel and unfair playing field. My opinion is that Federal Reserve actions over the last 10 or so years is largely responsible for the expanding gap between the have’s and the have not’s. This new action simply exacerbates this phenomenon.

Additionally, both fiscal and monetary policy are creating a situation of debt overload. Debt is simply borrowing from future selves to pay present selves. Debt stunts future growth through the burden of interest costs. Debt may defer pain, it may distribute pain over time, but it doesn’t eliminate pain. Consequently, debt is the best friend of politicians because it defers pain past the time they are in office. Yet debt will eventually ring our doorbell and expect payment. This latest debt frenzy only adds to the mountains of debt we already have accrued since our last deferment in 2008, which at that time only added to the deferment from 2001.

I suspect our time of delaying is getting shorter and shorter. The bill collector will eventually arrive and our “free ride” will eventually grind to a halt. Tax rates on all of us will need to rise, just to pay interest. Taxes for interest payments erode growth. Declines in growth eat away at the tax base creating a need for even more taxes. And the cycle continues. There is an alternative and that alternative is printing money to cover interest. That path leads to inflation or an erosion of the value of money. That path ultimately does not stop until all money is worthless. Eventually, whichever path we choose we end up like Dorothy, as Toto pulls back the curtain to reveal that the Wizard is simply a mortal man. We didn’t ask for this virus, but we are responsible for how we respond to it. Let’s hope our politicians and government officials can face this reality.

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