Will the Fed Cause the Next Recession?

A few weeks ago, our economic and market problems were widely seen as the fault of a slowdown in China, plunging oil and a rising dollar. Now there’s a new culprit: central banks around the globe. The Wall Street Journal devoted an editorial to the topic and the NY Times featured a print edition headline “New Fear That Central Banks Are Hindering Global Growth” (they changed the HED for the online version.)

The prevailing fear among investors last week was that U.S. central bankers, along with their developed economy counterparts in Europe and Japan, are pursuing or considering policies that will trigger the next recession – specifically, unlike the market’s buoyant reaction to large bond purchases (Quantitative Easing) to prompt growth, investors are less sure about the efficacy of negative interest rates. 

Let’s step back and think about this: The idea of charging banks to leave money on deposit with a central bank is meant to spur more lending, borrowing and spending for weak economies which are struggling amid deflationary forces. Like QE, pushing rates into negative territory should eventually boost growth and inflation. But the problem may not be the policy itself, but with the way central banks have communicated its benefits. According to Capital Economics, “the hesitant way in which they [the policies] have been introduced has undermined confidence, raising the risk that negative rates do more harm than good.”

No policy endeavor is without unintended consequences. Negative deposit rates will hurt banks, harming their profitability and potentially their willingness to make new loans. But more importantly, the concept of negative rates is being seen as a central bank Hail Mary. The thinking is “if they’re willing to go negative, they must have really run out of options!” That may be a purely emotional (after all, the Fed could start QE again if it wanted to do so), but who said that investors were rational?

Meanwhile, back in the real economy (vs. the stock market), there continues to be little evidence of a slow down outside of the energy and manufacturing sectors. In fact, on the back of decent jobs report, the government said Retail Sales were better than expected. The “control group”, which excludes the volatile categories of autos, gasoline and building materials, rose solidly in January. Economists pay attention to the control group because it closely mirrors the consumption portion of Gross Domestic Product. According to economist Joel Naroff, the “retail sales numbers don’t point to a recession coming any time soon.”

MARKETS: You know it’s a rough week when a 2 percent move on a Friday can’t save it. Even if there were some optimists in the buying crowd at the end of the week, chances are that much of the activity derived from short sellers buying back shares to lock in profits before a long holiday weekend.

• DJIA: 15,973 down 1.4% on week, down 8.3% YTD
• S&P 500: 1880 down 0.8% on week, down 8.8% YTD
• NASDAQ: 4363 down 0.6% on week, down 13.4% YTD
• Russell 2000: 972, down 1.4% on week, down 14.4% YTD
• 10-Year Treasury yield: 1.74% (from 1.84% a week ago)
• Mar Crude: $29.44, down 4.7% on week (despite Fri’s massive 12.3% rise, the largest one-day percentage gain since January 2009)
• Apr Gold: $1,239.10, up 7.1% on week, best week since Dec, 2008)
• AAA Nat'l avg. for gallon of reg. gas: $1.70 (from $1.75 wk ago, $2.24 a year ago)