'Why does anyone give a toss what the Fed thinks?'
It is surprising market watchers even care what the US Federal Reserve thinks given it has been wrong on just about everything so far, according to CLSA global equity strategist Christopher Wood.
Moreover, speaking at a select media lunch in Hong Kong yesterday, Wood suggested empirical evidence showed that quantitative easing policies were having the opposite effect of what they were introduced to do and are, in fact, deflationary.
He forecast the Fed would not raise interest rates this year, provided it was relying on what chairman Janet Yellen says it is focusing on – wage growth. “We have not got any concrete evidence at a macro-economic level that wages are rising, which is what she [Yellen] is looking at,” he said.
However, he noted, too, that Fed vice-chair Stanley Fischer has been clear about wanting to raise rates. “So we are about to find out who is really running the Fed,” said Wood. “That is the way you should be looking at it.”
In terms of wage data, Wood pointed to average hourly earnings growth, with June figures showing a decline once again (chart 1, below). Moreover, US inflation stands at 1.2% and is also declining against a 2% Fed target.
Additionally, Wood noted that US nominal GDP to M2 ratio had fallen from 2.03 in May 2006 to 1.49 in August 2015 (chart 2, below). “As long as the US velocity looks like that, it tells you inflation is not going up and it is telling you Treasury bonds remain in a bull market,” he said.
Wood pointed out that every year the Fed had been overconfident about the US economy only to have to downgrade its nominal real GDP growth forecast.
“The same is happening again this year,” he said. “The only amazing thing about this is that anyone in the market gives a toss whatever the Fed says, because it could not have been more wrong about everything.”
Wood pointed to the velocity chart above to emphasise how QE policy was having the opposite effect to what was intended. He said it was not having a positive effect on the US economy, only on asset prices.
He observed that rising asset prices only benefitted those who had assets, in other words the wealthier parts of the community as opposed to those living off basic wages.
“So the more asset prices go up, the more consumption is constrained,” Wood said. “The best area to be in is the services sector, servicing those high-end consumers.”
He said another problem with QE was that it sent government bond yields trending lower, causing net interest margins of banks to shrink and making them more cautious about lending.
QE also incentivises financial engineering as opposed to corporate investment, Wood said, as demonstrated by the fact there has been a boom in share buybacks in the US, with the S&P 500 share buyback index dramatically outperforming the S&P 500.
At the same time he observed the S&P 500 share buyback index had started to underperform since February, which he said was a sign of a problem in the stock market.
“If you are a CFO, the risk-reward ratio favours doing a share buyback, especially as your compensation is geared to return on equity,” he said.
While he noted there had been a big pick-up in commercial and industrial loan growth in the US, he illustrated data showing that when corporates were borrowing money it was for M&A and debt refinancings.
“All these reasons are why QE is deflationary,” concluded Wood. “The people who advocate QE have to explain why velocity has kept declining while these policies are being pursued.”