July 17, 2019
The Federal Reserve to self-grant itself a new role at July 30-31 FOMC meeting – Global QE Monetary Stabilizer: Last week Fed Chair Powell provided two days of semi-annual testimony to Congress on the economy. He essentially testified that the U.S. economy was healthy and expanding, but he had worries of global events and an inverting yield-curve caused by global monetary policy and slowing growth in Europe and Asia. He was subtly conveying to Congress (largely ignorant to monetary policy and economics) what Jim Grant (founder and editor of Grant’s Interest Rate Observer) wrote in a Barron’s feature the end of May titled: The World Created by Upside Down Interest Rates. I encourage you to read this article – as well as a follow up piece in the current edition of Barron’s and think about the following quote after the July 30-31, 2019, FOMC meeting and rate cut. Will anyone in the media be sharp enough to ask Fed Chair Powell to comment on this quote’s relevance to the cut?
“Five years into the negative rate experiment, and a decade on in radical monetary improvisation, the central bankers are looking for a way back to normalcy. Not finding it, they are casting around for new ways to control what they seem unable to understand.”
Prior to Fed Chair Powell’s testimony last week, I had been in the camp the Fed would NOT cut rates at their July 30-31, 2019, meeting as more monetary support is clearly not needed for a healthy U.S. economy characterized by a +2.5% to +3% GDP (Q1 GDP finalized at +3.1% and first reading on Q2 GDP due out July 26, 2019), below 4% unemployment rate, more job-openings than unemployed persons looking for work (JOLTS), record highs in the three major stock indices, and corporate earnings that continue to beat expectations and manage through tariffs for the third consecutive quarter. Just look to the bank earnings thus far this week by Citi, JPM, Goldman Sachs and Wells Fargo and global consumer staples companies like Johnson & Johnson. So what dots did I fail to connect that have changed my mind to the consensus thinking that the Fed is now going to cut rates at its July meeting? The short answer is I did not see the Federal Reserve taking on a third role - or self-assigned mandate as Global QE Monetary Stabilizer, in addition to the two granted by Congress: i) stabile prices; and ii) maximum employment.
The third self-granted role coming July 30-31: Fed Chair Powell and other voting FOMC members are now guiding that the Federal Reserve feels compelled to intervene in the global monetary market and thus take on a new role: Global QE Monetary Stabilizer (K.C. term). As the dollar has strengthened and global markets from Asia to Europe have slowed, global central banks and sovereign entities have taken to importing more of what the Fed created during the financial crisis – Quantitative Easing. This global QE and accommodative monetary policy is causing capital to migrate to the U.S. where there is growth and a positive yield on debt instruments and investments like equities. The unintended consequence is that we are seeing rapidly rising asset prices in stocks, bonds and hard assets, such as real estate, by global capital searching for yield. The thought process among global central banks has become:
“Hey, if the U.S. Central Bank can successfully jump start the U.S. economy by devaluing the dollar, loading up its balance sheet with debt instruments that couldn’t price or find a counter-party trade, and thus stimulating economic activity and exports, why shouldn’t the rest of us follow suit?”
In essence, the response by sovereign governments and central bankers is: “If blue jeans, Coca-Cola, Apple products, and Quantitative Easing monetary policy are good for the U.S. economy, why not the rest of us in Europe and Asia.” And now comes the unintended consequence.
The Federal Reserve initiated the “QE experiment” without any thought as to how to unwind it or the unintended consequences. I know this to be true from having being front-and-center at the New York Fed during the creation and implementation of all the intervening monetary and banking tools from bank stress tests, creation of TARP and TALF, to finally QE and the Fed intervening in the market to purchase trillions of dollars of assets for its balance sheet. The modus operandi from Treasury and the Federal Reserve 2009-2012 was borrowed from Nike – “Just Do It/Something.” You think I jest. Look at the latest data on how QE has spread globally and the amount of negative yielding debt in the world today.
Bloomberg recently reported that the world now has a staggering $13 trillion in negative yielding debt. Translated, investors are paying sovereign entities to take their cash and return less of it at maturity. How contrary to basic finance and investing principles is this behavior? Note the quotes (emphasis added by me) and key charts from this Bloomberg feature:
“The universe of negative-yielding bonds grew about $1.2 trillion this week after dovish messages from central banks in Europe and the U.S., pushing the total past $13 trillion for the first time. Joining the club of government debt with 10-year yields below zero this week were Austria, Sweden and France. Japanese and German rates plumbed fresh all-time lows amid a global bond rally that even got Wall Street pondering life with Treasuries yields under 1%.”
Negative Yielding Debt reaches Unprecedented Level of $13 trillion:
But wait, it is much worse. According to Bloomberg, it’s not just sovereign debt. "Approximately one-quarter of all investment-grade debt is negative yielding." And, junk bond debt has skyrocketed to double the levels it was a decade ago prior to the onset of the Financial Crisis.
“In the investment-grade market, negative-yielding debt now comprises almost a quarter of the total. And as companies take advantage of low interest rates to borrow more, issuance has helped drive junk bonds outstanding to more than $1.23 trillion, more than double the level a decade ago.”
Why does this matter; or should those of us in the commercial real estate industry care? Is not this news of a July FOMC rate cut welcome for C-RE investors looking to buy or finance an asset? In the short-run, yes; however, in the long-run it foretells a centuries long lesson forgotten about FIAT currencies and debasing the value of currency. A much respected colleague and friend (John Lifflander) published a succinct piece in June 2011 on topic titled:
How International Monetary Trends Affect Commercial Real Estate Values. He looked at the unintended consequences of debasing one’s currency. He traced FIAT currencies back to the Roman Empire and Song Dynasty in China around 1040 AD, and most recently Germany post-WWI. Below are three extracts from his paper that I encourage all to ponder as the Fed cuts rates at its July 30-31 meeting - essentially helping itself to a new third role. There is no question the Fed is cutting rates because the U.S. economy is weak or faltering, rather, it is intervening in the global currency market to thwart some of the unintended consequences from what it started with Quantitative Easing in the Financial Crisis. I fear we have a Fed overreaching its authority and engaging in monetary policy that is far over its skis - and its authority. We are about to go down a slippery slope in July that could have market consequences not unlike what we went through following the December rate hike.
Pay attention to Q2 Earnings and get ready for a plethora of fresh economic data ahead commencing with the first-reading on Q2 GDP on July 266, 2019, followed by a new jobs reports the first-week of August following the July 30-31, 2019, FOMC meeting. Q2 earnings are playing out as I had guided – beating expectations for the third consecutive quarter. Last week’s advice to “start refocusing on your 2H2019 strategies” couldn’t be more valid.
To assist on this refocus front, I will wrap up with a new report by McKinsey & Company on the “Future of Work.” It takes an innovative look at where employment destruction is going to occur by industry and type MSA. For those in our CRE industry trying to figure out where the disruption, new demand and adaptive reuse opportunities are likely to occur, check out this 2019 McKinsey Future-of-Work report. A few key charts to focus on are as follows:
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