No, This Fed Is A Hawk In Dove’s Clothing – Seeking Alpha
The Fed is being misunderstood. Many investors continue to cling to the belief that the Fed still has their back. But that thinking is so 2016. The Fed is not a dove in hawk’s clothing as one author recently proclaimed. Instead, the Fed is a hawk in dove’s clothing. And this identity distinction has important implication for stock investor portfolios going forward.
Hawks & Doves
A fine article was posted on Bloomberg View last Thursday entitled This Fed Is A Dove In Hawk’s Clothing. In the report, the author contends that although the Fed recently added another quarter point interest rate increase for the economy this past Wednesday, that they will struggle to continue on their path toward policy normalization. The author cites the marginal decline in the Fed member forecast for future interest rate increases through 2019 as evidence that despite the recent move toward tightening that the Fed will eventually back down because the economy does not warrant higher interest rates.
And the fact that the ECB struggled so mightily with its own attempt at policy normalization in the recent past will also deter the Fed from their own normalization efforts over time. As a result, the ‘goldilocks’ scenario for stocks (NYSEARCA:SPY) will continue to reign along with a bullish backdrop for gold (NYSEARCA:GLD) and a bearish outlook for the U.S. dollar (NYSEARCA:UUP).
The author presents a compelling argument, and he may very well be correct in the end. But I have a decidedly different view on the current state of affairs at the Fed. Instead of this Fed being a dove in hawk’s clothing, I would contend the exact opposite is playing out as we speak, as this Fed is a hawk in dove’s clothing. Here’s why.
Consider the following.
Credit Where Credit Is Due
First, let’s examine Fed Chair Janet Yellen’s entire body of work. While so many are inclined to slap the “dove” label on Yellen, a review of her tenure as Fed Chair reveals someone that has been cautiously hawkish throughout. After all, Yellen took control of the Fed in February 2014 in the midst of the Fed’s third and most aggressive quantitative easing program. At the time, interest rates were pinned at 0% and the Fed was adding assets to its balance sheet at a rate measured in billions each and every trading day. In short, the Fed was operating at a point of unprecedented easiness when she took control of the central bank.
It was two months after she was officially appointed to the job and a little over a month before she would finally take command that former Fed Chair Ben Bernanke helped start to set the table for the Yellen turn in monetary policy by initiating the taper of QE3 asset purchases in December 2013. But it has been since Yellen assumed the job in February 2014 that the Fed has been on a steady, albeit gradual, tightening path ever since.
Granted, I have been a vocal critic of the Fed in my writings on Seeking Alpha over the years for being far too accommodative with their monetary policy for far too long during the post crisis period. But credit must be given where it is due. For over her more than three-year tenure in running the Federal Reserve, Yellen has succeeded in first extracting the central bank from what had been introduced as a boundless asset purchase program in QE3 at its introduction in late 2012 and launch in 2013 before the end of her first year in late 2014.
In the time since, she has managed to raise interest rates off of the zero bound through four separate quarter point interest rate increases in the two plus years that followed. This is notable in and of itself, as no other central banker in history has succeeded in nabbing any more than two interest rate increases after first visiting the zero bound with interest rates.
In addition, she has laid out a course for further interest rate increases going forward including one more quarter point by the end of 2017 as well as three more in 2018 and 2019, which would result in the effective normalization of interest rates at around 3% if they are able to pull it off before the next recession strikes (HUGE “if,” but credit must be given for laying out the road map).
Lastly, the Yellen Fed has also just introduced a plan to begin shrinking the balance sheet that could grow to a rate of as much as $600 billion per year.
I have been critical of the Fed in recent years, but my agitation has focused more on the slower pace of tightening than the tightening itself. For when reflecting on Yellen’s tenure since the start in February, virtually everything she has done has been in the overall direction of monetary tightening, not easing. Although she entered in the most dovish environment in history, she has been consistently hawkish throughout in bringing U.S. monetary policy as far as she has back to the center.
Still a long way to go that could have gone at a faster pace along the way, but progress nonetheless. And when history reflects on the excesses that were accumulated during the post crisis period that will eventually need to be unwound, it should be the likes of Ben Bernanke, the European Central Bank (ECB) President Mario Draghi and Bank of Japan (BOJ) Governor Haruhiko Kuroda where the future ire should be concentrated, not on Janet Yellen.
So put simply, Janet Yellen has been a hawk in dove’s clothing since taking the helm of the Fed. And kudos to her for convincing the markets otherwise for so many years since. But then again, today’s markets will believe anything it hears that is bullish for stock prices (NASDAQ:QQQ). It’s an easy target.
Hawk In Dove’s Clothing
So how is this hawkishness playing out in dove’s clothing today? Let’s revisit some of the claims put forth in the Bloomberg article.
“The weak consumer price index report released just hours before the Fed acted Wednesday means the central bank shouldn’t be under pressure to increase rates.”
But they still went ahead and increased interest rates. And this is a stark departure from the more cautious approach that the Fed has taken in recent years. Conclusion: Something has definitively changed in the way the Fed is administering monetary policy going forward, which is that something other than current economic data is driving their need to raise interest rates and normalize policy sooner rather than later.
“The statement that accompanied the rate decision included the FOMC’s intention to “normalize” its balance sheet, but this is likely to be tougher than the Fed is making it sound. A similar strategy was tried by the European Central Bank, which shrank the size of its balance sheet from 3.1 trillion euros in June 2012 to 2 trillion euros in September 2014. That turned out to be too much for the euro zone economy to handle.”
I agree with the author that this is going to be a tall order for the Fed. But just because the ECB tried and failed in the past does not mean the Fed isn’t going to try today. And some key differences exist between where the ECB started in June 2012 and where the Fed is operating today in June 2017. First, the U.S. economy and its financial system is on much sounder footing versus where the European economy several years ago.
Second, the markets are showing themselves to be much more resilient today than they were a few years back. Lastly, the Fed has indicated that they plan on shrinking their balance sheet at a more gradual pace versus what the ECB tried a few years ago. So while the ECB set a poor past precedent, it does not mean that the Fed will be deterred today, particularly since other risks are now accumulating in the system after so many years of easy policy.
“After all, once hooked on the sauce of cheap money, financial markets don’t want to see the punch bowl taken away.”
This, in my view, is the biggest mistake that so many investors are making when reading the Fed in the current market environment. It is certainly an understandable mistake, as the Fed has demonstrated itself to be super sensitive to asset prices in general and stock prices (NYSEARCA:IVV) in particular throughout the post crisis period, but a mistake in my view nonetheless. The assumption is that because the Fed has been so aware of stock prices in the past, that they will continue to be so in the future.
But their language in recent months has repeatedly confirmed that they don’t much care whether stock prices continue higher from here or not. In fact, reading between the lines of what they have been saying, they wouldn’t mind seeing some steam come off the top of stock prices with a bit more volatility showing up in the mix. Don’t get me wrong, they don’t want to blow up the stock market and send stock prices down -30%.
But it seems that they would like to see valuations cool down a bit and prices rationally go down as well as up on the broader market on any given trading day. Conclusion: I don’t think the Fed really cares whether financial markets want the punch bowl taken away or not. They don’t necessarily want a tantrum, but they seem to need the punch for other purposes at this point, like preparing for the next recession.
“While equities face downside risks if U.S. fiscal policy fails, they are likely to respond favorably from lowered Fed rate forecasts.”
Indeed, the author makes a good point here. But if on the contrary this Fed is in reality a hawk in dove’s clothing, then equities are likely to respond poorly from Fed rate forecasts that turn out higher than what the market is currently pricing in. For example, CBOE Fed Fund futures are only pricing in a 46% chance of a Fed rate hike in December, which is the same rate hike that the Fed has already come out and told financial markets that it is planning on doing with the start of shrinking its balance sheet (another form of monetary tightening) getting started in the meantime, most likely in September. In short, if anything markets continue to underestimate, not overestimate the Fed and their resolve to tighten monetary policy further from here.
The Bottom Line
Many believe today’s Fed is a dove in hawk’s clothing. But I contend it is a hawk in dove’s clothing for the reasons cited above among others. And if this is indeed correct, this implies a bearish view for stocks (NYSEARCA:DIA). As for the gold (NYSEARCA:PHYS) and the U.S. dollar (NYSEARCA:USD), these are likely to continue moving to the beat of their respective drummers including a bullish outlook for gold (increased currency volatility and geopolitical/economic instability) and a bearish view for the U.S. dollar (weakening U.S. economic prospects despite higher than expected interest rates). It should be interesting to see how it all plays out.
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Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met.
Disclosure: I am/we are long PHYS.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am long selected individual stocks as part of a broadly diversified asset allocation strategy.