U.S. vs China Margin Debt – The “Global Mandate” Myth by Evergreen Gavekal

“As I grow older, I pay less attention to what men say. I just watch what they do.” 

–  Andrew Carnegie

EVERGREEN EXCHANGE
Tyler Hay, David Hay, Worth Wray

Tyler’s Summary – Connecting the Dots!

– The Fed’s decision NOT to raise interest rates last week was the single most important financial markets event of 2015.
Investors have been worrying about inflation, but it’s deflation that they should be worried about.
– The fact that the supposedly data-dependent Fed refused to raise rates with strong employment and stable inflation data suggests the committee believes something is deeply wrong with the global economy.
– Moreover, the fact that one voter called for European-style negative interest rates—not to mention Janet Yellen’s refusal to rule out such a radical reversal in Fed policy—leaves the door wide open for additional easing.
– While most investors expect rates to rise and bonds to suffer in the coming quarters, the risk of deflation is far higher than most investment firms, or even the Fed, care to admit.
– Rather than selling safe-haven US Treasuries because of low yields, investors should consider buying for price appreciation.

Dave’s Summary – No Exit

– Due to international risks, the Fed’s job has become more challenging and complicated.
– Rampant global money fabrication has created deflationary—not inflationary—pressures, also making the Fed’s mission more difficult.
– The Fed is now caught in a bind of feeling compelled to raise rates due to a decent domestic economy, but being afraid to do so because of market destabilizations concerns.
– Foreign central banks are also pressuring the Fed not to tighten and worries about another Chinese currency decline loom large.
– Because it has waited so long, the Fed may be forced to hike rates even as US corporate profits are weakening. If it doesn’t, bubbles in various asset classes may continue to inflate, and then inevitably implode.
– The Fed lacks the tools to deal with the triple global threats of spreading currency devaluations, excessive debt, and widespread industrial overcapacity.
– It’s likely that whatever Janet Yellen and her colleagues at the Fed do—or don’t do—even more serious market turmoil is probable.

Worth’s Summary – The “Global Mandate” Myth

– The Federal Open Market Committee’s decision to delay a rate hike in September was shocking not because of the delay, but because of the way the committee mis-framed its decision.
– The Fed has NOT adopted a third policy mandate aimed at preserving global stability.
– Should the labor market continue to tighten and inflation expectations remain relatively anchored, a Fed hike is still likely this fall.
– By poorly communicating its concerns over the recent market turmoil, the Fed is setting up a number of fragile economies and nervous investors for an even larger shock if it moves ahead with a hike in the near future.
– Watch out for a stronger US dollar, a weaker Chinese yuan, a broad-based emerging markets exodus, a deeper sell-off in commodity markets, an outright global recession, and an ugly correction for major equity markets around the world. If US equity markets initially rally on a Fed hike, it may be a good opportunity to get more defensive.
– While market panics can be scary, they can be extremely rewarding for investors who are prepared in advance with large cash reserves and a long-term perspective.


Connecting the dots! If you weren’t watching what happened at the last Federal Reserve meeting you may have missed the biggest piece of financial news so far in 2015. Before I get into that, let me bring you up to speed. On Thursday, September 17th Janet Yellen and the rest of the Federal Reserve Open Market Committee met to decide if they would finally enact a long-awaited increase in the level of the Federal Funds interest rate, known more simply as the fed funds rate.

Here’s how it’s supposed to work with regard to interest rates and the Fed. The fed funds rate historically serves as a key lever for the Federal Reserve to jump-start or cool the economy. Because the fed funds rate is used as the starting point from which many other interest rates are set, it has an enormous impact on the overall cost of borrowing within our economy. In the past, when the economy has been strong, the Fed would raise interest rates, making the borrowing of money less desirable and thereby moderating economic growth. On the other hand, when the economy is struggling to grow or contracting outright, the Fed is supposed to cut interest rates low enough to entice borrowers to take on more risk or invest in productive assets like factories or computers.

Countless people have opined about what should be done, but there are 17 members of the Fed (including the rotating regional Fed presidents) who will actually decide where rates go from here. Below is a visual diagram, released at the meeting, showing where different Fed officials would like to see interest rate levels over the coming years.

FIGURE 1: APPROPRIATE PACE OF POLICY FIRMING – MIDPOINT OF TARGET RANGE OR TARGET LEVEL FOR THE DEFERRAL FUNDS

Margin Debt

Source: Federal Reserve/Business Insider

The dots reveals some compelling and bizarre information. First, and most obviously, it tells us that almost all members are signaling that they want to see rates move consistently higher over the next few years. But this isn’t news; they’ve been saying the same thing for the last few years. Past dot plots have repeatedly shown the outlook for the current year’s rates being held at or around zero followed by fairly steep increases. Notice the red box, which indicates something fascinating: One member actually voted for negative interest rates. To clarify, this means you pay someone to lend them your money—more on that later.

Since the Fed has been posturing to raise rates and then postponing any action for going on three years, readers may wonder why I said earlier that their decision to not raise rates was the single biggest financial development of 2015. Here’s why I think what happened should have caught every investor’s attention: Investors are certain we are close to the beginning of rate hiking cycle, but I’m not so sure. Let’s consider the context. First, markets were prepared for a hike. Also, the Fed had said that they were taking a data-dependent approach to a hike. The data has looked pretty good. Employment looks decent. Prices, or inflation, looked stable. With markets braced for a rate increase and the Fed’s two criteria looking stable, a hike seems a very viable choice. If you add in the fact that the Federal Reserve realizes that having rates at essentially zero puts them in a vulnerable position, a raise seems even more logical. Instead, what did they do? They elected to not increase rates, and I think that this is pretty alarming.

Are they worried the economic earthquake that’s occurring in China could send a financial tsunami hurling towards the United States? Are they concerned that the strong dollar is choking the US economy and that further lay-offs from companies like Hewlett Packard and CAT are the tip of the iceberg? Are they frightened markets have been shaky of late and that

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