If you're wondering why stock markets are in such turmoil, look no farther than last week's commentary from the U.S. Federal Reserve Board. What it boils down to is that these financial geniuses don't have a clue what is going on in the world economy. If they don't know, with all the sophisticated data at their disposal, is it any wonder the rest of us are dazed and confused?
Just over a month ago, the Fed raised its key lending rate for the first time in nine years and signalled that we should expect as many as four more hikes in 2016. Now it's backpedalling away from that hawkish stance in the face of plunging global stock markets, more trouble out of China, downward revisions of growth prospects, and a soaring U.S. dollar.
Of course, no one at the Fed would express this in such blunt terms. That's not the way things are done. But take a close read of the nuances in the December and January statements and the implications are clear. "Committee" refers to the Fed's Open Market Committee, which sets monetary policy.
December: "…economic activity has been expanding at a moderate pace."
January: "…economic growth slowed late last year."
Interpretation: In the six weeks between the Dec. 16 and Jan. 27 meetings, something serious enough happened to cause the Fed to make a significant change in its wording on economic activity. The sharp stock market correction may have contributed but there had to be other factors involved.
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December: "Household spending and business fixed investment have been increasing at solid rates in recent months…"
January: "Household spending and business fixed investment have been increasing at moderate rates in recent months…"
Interpretation: In December, the Fed used the word "solid" to describe growth in these key sectors. In January, that was softened to "moderate".
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December: "…net exports have been soft."
January: "…net exports have been soft and inventory investment slowed."
Interpretation: Inventory investment becomes another negative for investors to chew on.
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December: "Overall, taking into account domestic and international developments, the Committee sees the risks to the outlook for both economic activity and the labor market as balanced."
January: "The Committee is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook."
Interpretation: The Fed is becoming increasingly concerned that there may be more downside risk to the global economy than previously believed. Dropping the word "balanced" is especially significant.
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December: "The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective."
January: No comparable statement.
Interpretation: The omission of such positive words as "considerable improvement" and "reasonably confident" says it all.
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December: "The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data."
January: No change.
Interpretation: The Fed is keeping its options open but based on the language elsewhere in the January statement the odds are growing against four increases in 2016.
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The big Wall Street indexes, which are highly sensitive to any hint of interest rate increases, plunged after the Open Market Committee released its statement. Despite the stand-pat decision on rates, investors were obviously concerned about the more pessimistic tone about the state of the U.S. economy.
The fact that the U.S. is not an economic island finally seems to be sinking in. For the past couple of years, the prevailing attitude in Washington seemed to be that the American economy is strong enough to pull up the rest of the world with it. That view is now rapidly dissipating.
The TSX has handily outperforming all the major U.S. indexes so far in 2016. Who would have expected that back on New Year's Day?
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters.
Gordon Pape