It’s late spring, and the Chicken Littles are back. They don’t fly but they do cluck. Ever since the US economy again showed barely any growth for the first quarter of the year, and even before, there was no end to the nay-saying commentators that jumped to cable TV attention by declaring that finally, after five straight springs of false predictions of trading or commercial collapse due to this or that – this was going to be the year that everything finally falls apart, like the Titanic after it came upon the iceberg!
Indeed, the metaphor of “chickens coming home to roost” – mostly in terms of the US Federal Reserve’s “highly accommodative” monetary policy – was a common theme. Ignoring the strong economic growth in the second and third quarters of 2014 (4.6% and 5%), the strongest back-to- back quarters since 2003 with a respectable 2.2% in the fourth quarter, the Wall Street Journal and a commentator for The Hill proclaimed it was time for the Fed to acknowledge that its policy of low interest rates had not worked to stimulate the economy, even though it had repressed inflation to below the 2% target. To its critics, the Fed has failed to promote economic growth, even though three million net new jobs have been produced in the last 12 months, because productivity measures remain slack and wage growth remains subdued.
The critics then go on to predict a train wreck in both the financial markets and the real economy when everyone realizes that the Fed policy has only harmed savers dependent of fixed income securities who have seen their coupons cut to historic lows reflecting the Fed policy of “suppression” of “safe” returns, designed to force investors into riskier assets (translation: “equity securities”).
Doomsayers saw bubbles everywhere: bubbles in the US bond market and even more so abroad as the European Central Bank (ECB) at long last adopted the Fed policy of government securities purchases (“Quantitative Easing” or QE) which has pushed German “bund” yields down toward zero. Renowned bond investor Bill Gross called the German bond market the “short of a lifetime,” meaning that the extreme increase in the price of bunds on trading markets (which depresses yields) did not reflect the real economy in Europe and would eventually reverse with a bang heard round the world. But it hasn’t happened because of the ECB’s QE!
Gross’s words had some immediate effects in the US bond market at the end of April and into May as good US job creation numbers for April reversed the slide below 100,000 for the prior month and suggested to some that the Fed might actually begin increasing the base interest rate above .25% as early as June. Prices on the ten year Treasury note dropped enough to raise yields as high as 2.27% on May 11 – up a third of a full percentage point just since late April, an extremely quick increase. Meanwhile, some surprisingly strong data on the German economy and in some other EU countries triggered a U-turn in the rise of the US dollar value vs. the Euro which in turn brought the quick rise in US Treasury yields to a pause.
In fact, it is equally likely that the increase in bond yields could also reflect the return of the “bond vigilantes:” i.e., those bond and derivatives traders, hedge fund players and institutional investors – all long-frustrated with the Fed policy for reasons having to do with their own incomes. The vigilantes – as they did in the “taper tantrum” of summer 2013 – take market positions, often in the futures markets which require a lesser risk commitment, designed to force bond prices down and yields up in order to literally force the Fed to raise short term rates sooner than its own judgment would indicate in order to keep up with the Treasury market’s rapid run up in yields.
Even the main target of the vigilantes in the past, former Fed Chair Alan Greenspan, weighed in with his own prediction of doom and gloom by predicting that the markets would experience the equivalent of another taper tantrum once the Fed increases rates, as happened in 2013 when Chair Ben Bernanke indicated in May that the Fed would begin later that year to reduce and eventually bring to an end its extraordinary program of quantitative easing due to the improving economy. Treasury yields spiked to the 3% level and stocks quickly corrected over 10% as investors bought in to the fear threat that the Fed was acting precipitously. The same voices now calling for a 40% market crash or at least a very painful “correction” as the Fed contemplates beginning to increase interest rates later this year (Marc Faber and Dennis Gartman, for example) are at it again with virtually the same scripts, and for a while produced the same results earlier this May.
CNBC of course chipped in with its usual “train wreck envy,” giving folks like Faber who have been wrong five years running a free platform to talk up his book; same for Gartman and others. And it worked for a while. The ten-year treasury note yield hit a high for the year; stock markets dropped below 18,000 on the Dow, 2100 on the S&P and 5000 on the NASDAQ and the “correction” prediction proliferated on the CNBC website and most every hour of live broadcast.
But investors finally woke up in the middle of this week to the fact that the drop in oil prices to fall as low as $10 a barrel predicted by Gartman just over six months ago that would continue to impede US GDP had in fact turned into an almost 50% increase from the 2015 low in the mid-$40s to over $60! That winter weather that cut into energy sector construction and production, along with the West Coast port strike that hurt multiple sectors including retail in Q1, were well and truly over. Also, that the rise in the US dollar, which held back earnings and revenues for US multinationals and technology companies with huge overseas businesses, had come to an end as the EU had bounced off its technical bottom. The Dow rose by 192 points even on a day where retail sales (as traditionally measured with heavy focus on department stores rather than the new mobility of sales of goods) showed virtually no growth month over month.
This time around, the market manipulations of the past five springs seems to have fallen on more skeptical ears. “Fool me five times, it’s my fault” seems to be the order of the day in the markets. And the continued decline in weekly average jobless claims – a 15 year low – as of May 14, also showed that the economy might just do this year what it did last year and push GDP levels approaching 3% for the rest of the year. The Chicken Littles are taking cover for the moment!
Recently published on Huffington Post.
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.