Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Perception (Mis)Management

With U.S. Treasury rates on the rise, Fed policy has likely hit a snag. Over the last three weeks, the 10-year Treasury yield has added over 50 basis points on the heels of what is believed to be improving economic conditions both here and abroad. Yet the “improving” economic conditions (spending) have been and are completely predicated upon rates staying low and going lower. If the Fed prints now, it may thrust the bond market into an unwanted tailspin as it did the last time it eased aggressively.

Complicating the issue, stocks have rallied to near previous highs on the basis of hoped-for and expected QE. If the Fed fails to deliver, it would be analogous to reneging on a contract, and stocks would presumably retaliate.

It’s counterintuitive, we know, but this is what we think the Fed will opt for at the next FOMC meeting September 1st: A course that causes some deliberate stock market weakness in an attempt to keep rates low, consumer spending intact, and money flowing into bonds. The status quo is likely to be in effect, where “jawboning” or promising to act “if needed” is all one can expect from the Fed – when it has no upside otherwise. A half dozen or so Fed officials have tended to agree. Two, in particular – the Fed’s Plosser and Fischer – have made the claim repeatedly that further Fed intervention would provide “very little benefit” to economic growth and or employment.

Lending credence to the belief that the Fed desires to place QE on hold was this week’s economic data. We say this since there appeared to be some “gaming” (more than usual) in the calculations. U.S. production, retail sales, CPI, and the Leading Indicators index all posted better than expected results – which helped fuel the ongoing “melt up” in stocks. As to their veracity, it appears that previous numbers (for June) were revised markedly lower, making month-to-month comparisons (into July) look better than they actually were. The inclusion of significant gas price increases made the nominal aspect of retail sales look good, while their removal from the CPI helped inflation figures look tame.

Shifting overseas, Greece applied for a two-year austerity extension, and Merkel may have given informal consideration to the idea. Actually, we’re not sure that much if any required austerity has been implemented by Greek officials to date, even after receiving two bailouts thus far. This is in contrast to recent agreements between Germany and ECB officials calling for austerity implementation before a bond buying program could be initiated. News emanating from Europe has had a tendency to contradict. The German parliament votes on a series of proposals next month (September 12th). We should have more clarity then – we suppose.

If we haven’t been clear, there is a crisis brewing – largely due to continuous Fed promises to backstop the markets, especially stocks. Without actual easing from the Fed, we’re not sure how the rally in stocks can continue unabated in the absence of needed fuel. Meanwhile, without lower rates, the “real” economy may pick up speed to the downside.

Metals investors may have understood this conundrum long ago, since they have been unwilling to advance on the basis of Fed jawboning, sensing there could still be a funding crisis for stocks. Arguably, the metals have already discounted the worst, given the longstanding and ongoing consolidative (profit taking) period. Whether the metals will rise as stocks fall remains to be seen. What can be said, though, is that for the first time in over a decade the metals are among the few undervalued assets extant. This, at the margin, increases their attractiveness in a crisis.

Best regards,

David Burgess
VP Investment Management