Note to Joe Q Public on Fed Policy: Promise in September, Deliver in December
“Do you remember the 21st night of September?”
So begins Earth, Wind and Fire’s classic anthem to the disco era. The words are simple, some even nonsensical, but then there’s that beat. In the words of National Public Radio, it’s “the song that never ends.” Forever timeless, ‘September’ endlessly infuses energy at wedding receptions, with some couples even choosing the 21st of September to say, “I do.” What is it about that one joyous cadence-rich melody that continues to deliver equal measures of both happiness and hope? There may be no clear cut answer other than how good it makes you feel, but it is one sure fire way to crowd the dance floor. “September” is so infectiously irresistible even hardened partisan politicos can’t help but bust a move — it roused the crowds of faithful at both the Republican and Democratic national conventions in 2008.
The beat was no less infectiously irresistible for then-struggling songwriter Allee Willis who caught the break of a lifetime when she was asked by EW&F’s leader Maurice White to co-write the band’s next album. As she recalls upon opening the door to the session, “They had just written the intro to ‘September.’ And I just thought, ‘Dear God, let this be what they want me to write! Cause it was the happiest sounding song in the world.”
The rest is history made in studio in 1978. With their creative juices flowing, this team closed their eyes, saw clear blue skies and then a star-filled night to be danced away. Willis does recall one niggle with the lyrics — that constant “ba-dee-ya”, that essentially meaningless refrain. When she insisted it be changed, White put his foot down to the benefit of generations of dancers who can’t help but break into their boogying best the minute they hear the song. “I learned the greatest lesson in songwriting from him,” Willis said of White, “which was never let the lyric get in the way of the groove.”
We have to wonder what Atlanta Federal Reserve Dennis Lockhart will remember when he next hears, “Do you remember the 21st night of September?” The date happens to coincide with his last September Fed meeting, marking the third at which markets had been set up for a hike only to be told to sit tight and wait for December.
In the event history escapes you, or you’d rather forget, both the 2013 and 2015 September Federal Open Market Committee meetings concluded with promises of more to come, in December, that is. Four years ago, the markets had been beaten into submission after throwing a hissy fit for good measure. The doctorate holders at the Fed were finally prepared to reduce the addictive Quantitative Easing drip from its $85 billion per month rate, and investors were ready for it. Taper anyone?
Then of course, something gave Committee members pause, and they blinked. The follow through on the threat would not arrive until the stockings were hung by the chimney with care. As for last September, the markets were braced for the Fed to lift rates off the zero floor for the first time in seven years. The Chinese, however, had taken offense to such potential action and forced the FOMC’s hand, to the market’s surprise. Taking a cue from 2013’s script, they stood and delivered just in time for the holidays.
And this year? It seems that investors have begun to feel as if it just might now be them rather than Feb Officials suffering the existential crisis. That’s the only way one can describe being on the receiving end of what has to be FedSpeak at its absolute peak in the contradictory department. Will they? Won’t they? “He said…” “She said…!”
One Fed official in particular has become vociferous in his hawkish implorations. Boston Fed President Eric Rosengren has spotted a bubble in commercial real estate and is officially worried. The problem is, that train left the station long ago when insurance companies buckled under the strains of a low interest rate world and lowered their minimum acceptable return bogeys. All manner of institutional investors followed suit and the rest is history.
And it’s not just commercial real estate. Fill in the blank with the name of the asset class and valuations are as stretched as they’ve ever been or perilously close if you can get an accurate measurement.
Take the lowest hanging fruit – U.S. stocks. Just imagine what the real price-to-earnings ratio would be if you could scrub it clean of the last few years of share count reduction to say nothing of interest expenses being kept at artificially low levels care of the Fed. Remember, we’re talking earnings PER share here, folks. Then for good measure, consider the starting point for your valuation fix: the aggregate stock market capitalization vis-à-vis the size of the U.S. economy, which is higher than at any time since the dotcom boom. Get the picture?
Take the next turn into Corporate Bond-ville. There’s precious little to see unless you factor in actual defaults and what Standard & Poor’s calls the “weakest links,” as in most likely to be the defaults of tomorrow. Both of those gauges of stress are at their highest levels since 2009 and it’s way more than an energy story; only one in four weakest links are tied to yesteryear’s shale credit spree.
As for the toniest enclaves, filled with occupants sporting investment grade (IG) credit ratings, Bloomberg’s Sally Bakewell deserves a full round of applause for her reporting on the dangers lurking in IG bonds. In a recent article cleverly titled, “Leverage Soars to New Heights as Corporate Bond Deluge Rolls On,” Bakewell notes alarm bells ringing on both the buy and sell sides of the Street even as bond issuance celebrates its fifth consecutive year of $1 trillion-plus issuance.
For starters, a recent Morgan Stanley report warned of the perils of Corporate America’s overall leverage sitting at a record 2.4 times earnings. Take this as gospel: sell side analysts are not in the habit of pouring water on a smoking hot party, not unless they’re so worried they can’t help themselves (it makes the investment bankers upstairs a bit testy). For a bit of context, the leverage ratio most recently troughed at 1.7-times back in 2010 as the economy was emerging from recession.
As for the longer history of the gauge, the only time the ratio has been this high is in the aftermath of the stock market implosion of 2000. (Yes, Virginia, credit booms really do get served the last drink at the end of the cycle, peaking after stocks and the economy have already rolled over.) That last bit apparently has Morgan Stanley’s analysts quite concerned: “Leverage tends to rise most in a recession – so the fact that it is this high in a ‘healthy economy’ is even more concerning. Mistakes are both more likely and more costly.”
As for the buyside, Bakewell was wise to tap into Alliance Bernstein’s Ashish Shah’s wisdom. He is both a friend and one of the best veteran fixed income strategists out there. “The investment-grade ‘safe’ part of the market is becoming the most dangerous,” said Shah. “There is so little return out there. People are crowding into whatever they can.”
Yours truly bemoaned the startling growth in IG back in February in Midnight in the Garden of Fallen Angels.
As for what’s going on in 90210, in the so-called hard asset classes, it’s simply magnificent. The high end has never been higher. Anecdotal testimony in the form of TV programs and glossy magazines oozing with depictions of everything in excess provide ample evidence that everything from mansions to diamonds to vintage port to private jets have never flown at such altitudes. As one tweeter quipped recently, “QE has served as no more than a gift to the wildly rich.” Indeed.
And so it is. To Rosengren’s point and the others made heretofore, financial instability is conspicuous in its ubiquity. And yes, it would be nice to be able to hike rates to staunch the speculative fervor. But it’s just not meant to be.
For all the bullish bravado being spewed by the last standing hawks at the Fed, the simple fact is the economy cannot sustain a rate hike in its current fragile state. Take the current state of two pillars of support for the weakest recovery in postwar history: autos and energy. With peak sales in the rearview mirror, car lots are choking on inventory. Meanwhile, the price of oil refuses to acquiesce to the will of companies determined to drill, baby, drill.
One loyal reader said it best in response to last week’s piece on household finance: “Systems without resilience are brittle and subject to large changes from relatively minor unexpected inputs. I’m afraid that’s where we are now.”
If that is really where we are, now might be a good time to push replay on “September,” Earth, Wind & Fire style. If that’s not enough to lift your spirits, do as the markets are inevitably doing about now, look ahead to “December.” But this time, also do it Earth, Wind & Fire style. Huh?
File this away in the “Who’d a thunk it” department: Recognizing the good vibes they had bestowed upon revelers worldwide, Earth, Wind & Fire was kind enough to revisit the lyrics for “September” and mold them into a holiday tune brilliantly titled, “December.” Call it the song that keeps on giving.
As for the Fed, all things considered, we can only hope this December does the opposite, ending the era of promising today and delivering tomorrow. Recognizing that monetary policy cannot address all economic ills. Acknowledging they missed an entire rate hiking cycle and apologizing for doing so. Committing to do less, not more, this next recession, thus forcing Congress’ hand. These are the steps that could be taken to restore what the Fed has long since lost, it’s credibility. If instead, the Fed gambles on forever being on the winning side of the confidence game and nothing more, well then, what’s to come will give new meaning to Game Over.
Originally published on Danielle DiMartino Booth’s website.