The Fed Is Playing a Dangerous Game

Monday, March 4, 2019
By Paul Martin

By: John Mauldin
Monday, 4 March 2019

Infested with Crawdads
Not Applauding
Steadily More Dovish
#3 Mandate
Puerto Rico, Cleveland, New York, Cleveland, Austin, and Dallas

In an ideal world, we wouldn’t have to read the Federal Reserve’s rabbit entrails to discern the economy. But Since the Fed exists in the real world, and its decisions matter, we have to pay attention.

Just so new and perhaps even old readers know my views on the Fed: I believe we need it to handle the practical matters of the banking system plus interact with other international central banks (we live in a complicated world) and, in the midst of crisis, act as a lender of last resort and liquidity provider. I agree with Walter Bagehot’s(pronounced badget) very important pronouncement (often called “Bagehot’s Dictum”) that “in times of financial crisis central banks should lend freely to solvent depository institutions, yet only against sound collateral and at interest rates high enough to dissuade those borrowers that are not genuinely in need.” That rule or dictum remains wise.

I would prefer that the market set rates at the lower end as opposed to the Federal Reserve, again, except in times of crisis. I don’t believe 12 people sitting around a desk, no matter how brilliant and educated they are, can arrive at a proper market-clearing rate better than the market itself. Seriously, LIBOR was set for decades without government intervention. Yes, in times of crisis it got a little funky, but that is when you want the central bank to step in (and then get out as soon as possible).

Before we get back to the letter, let me remind you we’ll be talking about the Fed and a lot more at my Strategic Investment Conference in Dallas from May 13–16. If you want to attend you had better act quickly because it is almost sold out. Seriously. We intentionally limit the number of attendees to keep the conference from becoming so big that it becomes impersonal. We just added a Very Important Speaker to help us understand how future central bank policy will impact your investment portfolio and what you can do to insulate yourself.

Not only will this be the largest SIC ever, it is going to be the most informative and impactful. You don’t want to miss it. We’ll start a waiting list when it sells out but you really, really don’t want to take that chance. Click here to register now.

Infested with Crawdads
Following Fed policy has been whiplash-inducing over the last year. It was just two months ago that Jerome Powell set off a market panic by suggesting the FOMC would do what it thinks is right and let asset prices go where they may. They were promising at least two if not three more rate hikes in 2019. The stock market fell out of bed.

Fast-forward to now and it seems the market won and got the “Powell Put” it wanted. The Fed has given up its tightening dreams and might even loosen policy. It is even (gasp!) losing its fear of inflation.

Nassim Taleb in his book Antifragile argues that preventing small “crises” from happening on a regular basis eventually causes a very large crisis. It’s analogous to not allowing small forest fires to clear out undergrowth. Eventually you get one very large fire which is far more destructive. The Fed assuming a “third mandate” to protect asset prices is similarly dangerous.

Not Applauding
To understand what’s going on, we need to review some ancient history, and by “ancient” I mean December 2018. That’s several eons ago in today’s news cycle.

Recall what had just happened. The US stock benchmarks had peaked in September before weakening to create a rough fourth quarter. The Fed was continuing to raise rates even as President Trump grumbled they were hurting the economy. In early December he had called a temporary delay on higher Chinese import tariffs. That helped a little but Wall Street was still worried. The Fed seemed tone deaf.

On December 19, following a regular FOMC meeting, Powell held the usual news conference which was, not to put too fine a point on it, a disaster. The more he talked, the more markets plunged as he seemed to dismiss concerns the Fed was affecting asset prices.

I said two days later in Powell, the Third Mandate, the New Fed and Crawdads that I thought this was exactly the right move. Powell’s predecessors had given the Fed an unofficial third mandate: defend stock prices as well as maintain low inflation and full employment. His comments that day seemed to reveal Powell had no interest in continuing that practice.

The Rest…HERE

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