1ST 100 DAYS

Here's a comment after last night's Obama's speech. Today marks this presidents 100th day....

Regarding the Fed’s statement of policy yesterday (which were pasted in yesterday’s Afternoon Note), David Rosenberg, an economist at Merrill Lynch (now part of Bank of America) published some interesting comments late in the day.





Mr. Market is to be respected, but he is not always correct

We find it rather difficult to square today’s Fed press statement with the amazing reversal in investor sentiment towards euphoria over the past several weeks. The equity market is, as we all know, a forward-looking barometer, and now seems to have gone further than merely pricing in “green shoots”, to discounting the righthand side of the ‘V’. Mr. Market is to be respected, but he is not always correct.

Fed has a more somber forecast than Mr. Market

The Federal Reserve does possess the largest US macroeconomic model on the planet, and although the central bank acknowledged the obvious today (that “the pace of contraction appears to be somewhat slower”, which was hardly a resounding endorsement for the second-derivative viewpoint, in our view), it seems to have a much more somber forecast of the economy (that “economic activity is likely to remain weak for a time”) compared to Mr. Market.


Disconnect between Fed & market’s ability to sustain rally. Although the “outlook has improved modestly since the March meeting”, the operative word is “modestly”. In addition, the “remain weak for a time” quote resonated with us even if the market has largely shrugged it off. The Fed certainly does not have a perfect forecasting track record , but let’s just say that there does appear to be a disconnect between the central bank’s choice of words to describe the economic backdrop and Mr. Market’s ability to sustain this vigorous rally.

Never in the past 60 years have prices dropped this much

As for Treasuries, the selloff continues unabated, and comes on a day when real GDP contracted at over a 6% annual rate with confirmation of a deflationary environment with the gross domestic purchase deflator (GDP deflator ex trade) declining at a 1% annual rate on top of a 3.9% annualized slide in the fourth quarter of 2008. In fact, at no time in the past 60 years have we seen domestic prices fall this much over a six-month span.

Fed views deflation as the primary risk

Perhaps the market was expecting that the Fed would announce more in terms of the size of its bond-buying program (which was not forthcoming) and viewed the press statement as a disappointment. But as we stated this morning, periods of deflation in the past were typically met with long-term yields in a 2-3% band with near consistency. The Fed may have tweaked how it portrayed the current climate in today’s statement, but what it did not change was its view that deflation remains a primary risk – “the Committee sees some risks that inflation could
persist for a time below rates that best foster economic growth and price stability in the longer term”.

Too much slack in the economy to worry about inflation

The fact that the Fed can state this view, knowing full well that it has dramatically expanded its balance sheet and the money supply, is a testament to the view that the central bank has been leaning against the winds of deflation rather than creating inflation. In our view, the latter will be practically impossible to do in an environment where the underlying unemployment rate is approaching 16% and capacity utilization rates are at all-time lows of 66%. There is simply too much slack in the economy, in our view, for us to be worried over the prospect of inflation or a sustained bear market in bonds.