Poor Yellen. She has a tricky line to walk. There can be no denying the Fed would love to take the economy off its zero interest rate policy. But the economy is far from robust, and they are desperately scared of snipping any recovery in the bud. In the mean time, the accommodative monetary policy continues to fuel speculative bubbles in financial asset markets.
We are now well over five years since the credit crisis. When hawkish Fed Governors hark about “the time for the emergency zero percent interest rate is well past” it is difficult to fault them.
Yet the level of inflation is consistently running below their target. There has never been a start of a tightening cycle with the level of inflation below target.
I contend we are getting inflation; it’s just not in the CPI. We are getting financial asset price inflation. Like an addict, the Fed has returned to their old ways. The easy monetary policy of the past half dozen years has created another speculative financial asset bubble. Five years of QE will do that…
I would have never guessed that the Fed could create another financial asset bubble. I was sure their balance sheet expansion would go into assets they didn’t want to rise. I was wrong.
The financial markets have succeeded in creating a new bubble that rivals all the previous ones put together.
But the problem is that the Fed is scared to withdraw this crutch because it might trigger the start of the unwinding, which might derail the economic recovery. So the Fed is being “patient” with their interest rate increases.
Yet as they continue to be “patient” the bubbles just grow all the bigger.
Today Yellen is testifying in front of Congress in her Humphrey Hawkins appearance. Last year when she delivered her report to Congress she noted:
Nevertheless, valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year. Moreover, implied volatility for the overall S&P 500 index, as calculated from option prices, has declined in recent months to low levels last recorded in the mid-1990s and mid-2000s, reflecting improved market sentiment and, perhaps, the influence of ‘reach for yield’ behavior by some investors.
These comments were made last summer on July 25th. Let’s have a look at how these sectors have performed since her warning.
The social media stocks have stopped rising. At least the publicly listed ones have. Although the Facebooks and Twitters of the world are no longer exploding higher in valuation, you would be hard pressed to argue that the bloom has come off the rose for this sector.
The market for Silicon Valley startups is still so hot that wise venture capitalists are issuing their own Yellen style warnings. From the WSJ:
After speaking about the risks of “cramming” too much money in startups at the Goldman Sachs technology conference last week, venture capitalist Bill Gurley exited the stage.
More than a dozen investors swarmed the lanky partner of Benchmark, eager to speak with him— but few were planning to heed the venture capitalist’s advice. According to Gurley, one man, who represented a large mutual fund, asked, “You don’t want us to invest in this but the big tech stocks are not delivering enough growth and my competitors are getting into these startups, so what are we supposed to do?”
Gurley says he didn’t have a good answer but he wasn’t surprised by the sentiment, which he describes as FOMO, a slang popular among millennials that stands for “fear of missing out.”
It is this infectious FOMO, according to Gurley and other venture capitalists, that has created a flotilla of billion-dollar startups with ever-soaring valuations and mixed financials.
Gurley says he knows his opinion is in the minority.
“This is the most crowded party that’s ever been thrown,” he said.
Although the easily tracked publicly traded social media valuations have not risen since Yellen’s comments last summer, the bubble has become even bigger – the party just moved to a new location.
The other area of Yellen’s concern – the biotech bubble is much easier to spot.
Since last summer’s comments, the biotech index is up 60%. If Yellen was worried about biotech last summer, what does she think now?
She must be shitting bricks about the possibility of this bubble getting out of control. She does not want to raise rates – we know that for certain. She wants to leave rates low enough for the lower and middle class to experience some benefits from the recovery. Yet so far her easy monetary policy is mainly helping the 0.01% through the blowing of more asset bubbles.
What she wants is for her easy money policy to accrue the benefit to a different area of the economy.
In today’s Humphrey Hawkins I expect her to cautiously prepare the markets for rate hikes later this summer. She will try to stress they will be patient but not reckless.
Yet I expect her to double down on her worries about the financial asset bubble. If she was concerned about the valuations and sentiment last summer, she has to be terrified today.
She will attempt to surgically talk down asset prices, yet give a reassuring message about the economy.
It will be a difficult line to straddle. But if I had to guess, I would lean towards the idea that the stock market will not like the next couple of days.
I sympathize with Yellen’s predicament. She has been handed a can’t win situation. The real answer to this problem is to never reach this point in the first place…