Why the US Federal Reserve Is Creating A New Narrative

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The general consensus is that stocks (doesn’t matter which ones, pick anything) are in a megatrend too. The Dow breached 17,000 points overnight, which is neither here nor there, but the media loves it. They’ll soon latch onto the significance of the S&P 500 crossing 2,000 points. That’s a mere 15 points, or one or two trading sessions, away.

But can’t stocks go down? Not anymore by the look of things. And certainly not according to this article, which boldly claims that ‘the SPY (S&P500) is NOT extended and may NEVER pull back’. Gee, you better get in and buy then…

Strong employment data released overnight was the reason for the latest US stock market surge. By the way, the employment data came out a day early this month because the US celebrates Independence Day tomorrow. Oh what the Founding Fathers would say about their great republic! A constitution flushed down the toilet…the dollar beaten relentlessly around the ears for a century…Congress a cesspit of deceit and corruption. How proud they would be!

But I don’t mean to be a party-pooper. Happy Birthday United States, get stuck into it…

Anyway, the US economy created 288,000 jobs in June, with upward revisions made to the May data. The labour force is undoubtedly strengthening. The unemployment rate dropped to 6.1%, the lowest rate since September 2008, which, incidentally, was before it all went pear-shaped.

A few months ago, the markets would have taken this good news as bad news. But recent speeches by US Federal Reserve chief Janet Yellen have convinced the punters that economic and labour market strength won’t be a barrier to keeping interest rates low. It’s the best of every world there is…and apparently this scenario isn’t priced in!

What’s incredible about all this is the psychological angle. I’m reading an increasing number of articles justifying this high price/low interest rate environment, and why it will persist forevermore.

Bill Gross, head of bond fund PIMCO, made a heroic effort to do this recently…probably because his bond fund has been bleeding money for a while now. He’s pitching the ‘New Neutral’ idea (because the ‘New Normal’ idea he previously pitched didn’t really fit in with a relentless bull market).

The New Neutral is an environment where real interest rates are closer to 0%, rather than the previously thought 2% advocated by John Taylor of the ‘Taylor Rule’. In the New Neutral, the Federal Reserve can maintain this status quo, stocks will advance and the economy will hum along in a goldilocks fashion (yes, he said goldilocks) without inflation ever becoming a problem.

He’s not a raging crazy bull though. That wouldn’t befit a bond fund manager. In fact, it would be bad for business. Here’s how he sees it:

‘But to the point – if The New Neutral is closer to 0% than 2% – if Taylor is replaced by PIMCO’s New Neutral – then risk assets, even without QE checks, can stand on their own two legs. They won’t be stilts, more like peg-legs in a historical context, but stable nonetheless. We expect bonds to return 3-4% over the next 5 years and stocks perhaps 4-5%. If central banks proceed cautiously, there’s no need for another Lehman Brothers, but as well, there will be no interest rate propellant for double-digit asset returns. Those days are gone. The journey to 0% nominal Fed Funds and a negative 1½% real rate is over. A 0% real Fed Funds New Neutral lies ahead, a tightening of credit yes, but a mild one to be sure.’

I don’t know if Gross is right or not. That’s not the point. The point is that Gross represents the views of the big money oligarchs, and the new narrative of these oligarchs is that the Federal Reserve will tighten, but not by too much…and the bull market will roll on.

A few weeks ago I wrote of the need for investors to create narratives, or stories, about the market to give them some sense of comfort and understanding about what is going on. The truth is that no one really knows what’s happening, the world is random and unpredictable…yet we try to understand.

I also wrote that ‘If we believed that the world is truly random and unpredictable, and chaotic and cruel, we’d be in a state of anarchy.’

A mate of mine, who is a long time reader of The Daily Reckoning, picked me up on this, and rightly so. Take it away Scotty…

‘Anarchy — correctly defined — is simply a stateless society; a situation where no ‘body’ or organisation holds ultimate power over individuals within the society. Self-organisation (or self rule) is the result of anarchy. The idea that a stateless society would see us descend into chaos is a furphy.

‘Furthermore, if one considers that most of the ills of society are caused as a direct or indirect result of the actions of the State, I would suggest to you that a descent into anarchy cannot come quick enough. Anarchy should be the goal of all individuals in the interests of us all living truly free and prosperous lives.

‘Anarchy is everywhere. Without anarchy as the default state, the whole world would disintegrate. Not only is all human progress due to it, but so too is the entire evolution of the ‘natural’ environment. All order extends from anarchy. All things that rise above the state of nature are owed to it. When humans truly thrive, it is only because of a lack of controls, not because of controls. If any of us wishes to live in a more beautiful society we should each strive to reduce the controls in our lives.

‘It’s a paradox that must forever be explained.’

With this in mind, it’s obvious why central banks and governments are so keen on keeping the party going. It’s not to create employment or keep inflation low. It’s to maintain power and control. To keep us subservient to the new class of financial oligarchs. Without our belief, they are nothing.

Read the rest of this article at The Daily Reckoning