Is This a Short-Covering Rally or a “Real” Recovery?

October 13, 2015


By Louis Navellier

All content in this Introduction to Marketmail represents the opinion of Louis Navellier of Navellier & Associates, Inc.
Is This a Short-Covering Rally or a “Real” Recovery?
The S&P 500 is up 4.94% so far in October (through last Friday), but it has been led by a short-covering rally of low-quality stocks that may not be sustainable. We’ll know more in the upcoming weeks, after we hear more third-quarter earnings results and guidance. As always, I remain very confident that stocks with superior fundamentals will benefit from positive sales and earnings surprises and positive guidance.

Last Thursday, Bespoke Investment Group (in B.I.G. Tips: “Buying the Losers”) showed that the S&P 500 gained 6.5% from September 29 to October 8, but the past “losers” rose four times faster than the previously “safest” 10%. Specifically, the top 10% of stocks that fared the best from the market’s peak (on May 21) to September 29 only gained 3.72% in the next seven trading days but the worst performing stocks (the bottom 10% since May 21) performed the best, up an astonishing 15.38% since September 29.

Last week’s market leaders are ironically stocks that are expected to post horrific sales and earnings. Energy stocks have been amazingly strong. Despite lower global demand in the autumn months, crude oil prices have drifted higher on news that inventories are declining. However, the inventory of crude oil and gasoline remains well above historical levels, so the rally in energy stocks appears to be somewhat related to short-covering. With slower global growth, I do not expect crude oil to continue to rally this strongly.
In This Issue
One reason why oil prices might spike temporarily is the escalating war in the Middle East, as Ivan Martchev shows in Income Mail. He’ll also examine the latest trends in the Japanese yen. In Growth Mail, Gary Alexander will show why the threatened “earnings recession” could be short-term and irrelevant. In Sector Spotlight, Jason Bodner will examine the recent revival of the three least-loved S&P sectors; and then I’ll return with a rundown of leading economic statistics and an analysis of the latest FOMC minutes.
Income Mail: The Eye of the Storm
Here Comes the Oil Spike
by Ivan Martchev
Growth Mail: Experts Often Warn about Crashes after They Happen
Time for a Reality Check on Earnings
by Gary Alexander
Market History: Is October 13 a Lucky Day – or Not?
Happy 240th Birthday to the U.S. Navy
by Gary Alexander
Sector Spotlight: Three “Unloved” Sectors Lead This Recovery
Can This Energy-Led Recovery Continue?
by Jason Bodner
Stat of the Week: Trade Deficit Rises 15.6% to $48.3 Billion
The “Doves” are in Control of the FOMC
by Louis Navellier
High Yields in Both Stocks and Bonds
Income Mail
All content in “Income Mail” represents the opinion of Ivan Martchev.
The Eye of the Storm
By Ivan Martchev
It is absolutely fascinating that for over six weeks the Japanese yen is still trading within the daily range of August 24, when the Dow suffered its record 1000-point-down opening. I mentioned that last week but the yen’s “coiled spring” has kept on winding. Based purely on the triangular consolidation that resembles a pennant flag – which I have conveniently drawn in red below – we are about to witness another surge in volatility coming from the unwinding of yen carry trades.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
I would be the first to tell you that I don’t put a lot of stock in squiggly lines, trend lines, and other technical mumbo jumbo unless I spend some time understanding what is going on behind the chart. Unless you understand the supply and demand forces that make those bars move, as is the case with the USDJPY bar chart shown above, you are bound to make some stupid trades.
In the charting business, a pennant flag indicates a surge in volatility followed by a compression, or decline in volatility. Typically flags tend to resolve themselves in the direction they point, in this case down. It is a bit confusing in this case since the USDJPY rate is going lower, i.e. fewer yen per dollar, meaning a stronger yen. So what would be considered a bear flag in any other chart here indicates more yen strength to come. If the yen appreciates below 118, this means the USDJPY rate can go all the way to 110-112, or appreciate as much as the length of the flagpole from the point where the flag breaks (118).
What fascinates me about this technical setup is that the fundamentals of the yen are bearish – it should be going lower (more yen per dollar), purely based on the aggressive action of the Japanese central bank. The yen is easily the most bastardized major currency on the planet today, based on the fact that Japan’s version of QE is three times more aggressive than the U.S. version, relative to the size of Japanese GDP.
With the BOJ in pedal-to-the-metal printing mode, I am confident that the yen will go lower over time, like the next 3-5 years. What happens in the next 6-12 months is another matter, as 116 is the bottom of a consolidation range that has held for nearly a year. So I would consider a move of the yen past 118 to be a yellow flag for investors. The “red” flag is a move below 116. I expect that if the yen appreciates past those levels, we would be seeing a surge in volatility in more than one asset class as the yen is used as a funding currency in carry trades in bonds and stocks, and an appreciating yen likely means the unwinding of such carry trades.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The S&P 500 Volatility Index (VIX) strikes me as confirming the compression in the USDJPY cross rate. The VIX has declined from a panic high of 53 in August, down to 16 last week. The S&P 500 has had a couple of successful tests of those August 24 panic lows, but it is sitting at a major resistance level just above 2000.
In my opinion, those V-shaped recoveries that we witnessed in 2013 and 2014 are unlikely to get repeated in this case. We need a much-better-than-expected earnings season for the stock market to move higher. Subdued volatility in stocks (as reflected by VIX) and the bear flag in the USDJPY cross rate independently suggest that markets are about to shake, and soon.
Here Comes the Oil Spike

As discussed last week, the commencement of aerial bombardment by the Russian Air Force on terrorist targets in Syria is likely to be reflected in the crude oil futures market as the counteroffensive is likely to push ISIS and other anti-Assad elements right into the major oil producing regions of Iraq. The Russians also shot quite a few Kaliber mid-range missiles from ships stationed in the Caspian Sea, which hit their targets in Syria. There is no doubt that this was intended also as a show of force as they have ships carrying similar missiles off the Syrian coast but they chose to make the strikes from ships stationed 1500 kilometers (930 miles) away, crossing both Iranian and Iraqi air space with the necessary pre-clearances.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The Russians have said that the aerial bombardment will intensify and this seems to be confirmed by the latest numbers on Saturday that showed 64 sorties against 55 targets within 24 hours. The intensifying bombardment can be seen in the oil futures as December 2015 oil moved up all week and closed above $50. It is easy to see that the more missiles fall in Syria the more the price of oil will reflect it. So far crude oil futures are up about $5 since the Syrian air campaign started. I can see futures rising $20 to $30 if the Syrian Army recaptures Raqqah and ISIS is pushed over the border with Iraq.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
I always wondered how ISIS can earn substantial oil revenues (to the tune of hundreds of millions of dollars). Who are the middlemen helping them move the oil? There is something fishy in this captured oil terrorist financing scheme that is rapidly coming to a halt as the Syrian counteroffensive begins.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The dilemma to investors in energy-related instruments is that this latest move in crude oil futures is geopolitical in nature and not supported by the forces of supply and demand. There is too much supply and not enough demand at the moment and we may very well see more supply and less demand courtesy of the Chinese economic unraveling that will be affecting many emerging markets in the next year.
In my opinion, this makes the coming spike in oil a spike to sell.
The trick is figuring when the spike fizzles out. If ISIS looks like it is about to cease to exist as a terrorist organization and there is progress against them in Iraq, that would probably be the time to no longer be looking for more upside in oil. Since this is likely more than a month or two away, some oil spikes in the meantime may turn out to be truly extraordinary.
Growth Mail
All content in “Growth Mail” represents the opinion of Gary Alexander.
Experts Often Warn about Crashes…After They Happen
By Gary Alexander
“Profit and earnings ratios are starting to get to the point where buying stocks is a potentially good deal if you’ve got a long-term perspective on it.”
– President Barack Obama on March 3, 2009 (three days before the market’s bottom)
Our President made a great market call in early 2009. By contrast, those paid to make such forecasts have issued a series of belated warnings lately. Last Monday morning, after I sent Growth Mail to the staff at Navellier, I opened Ed Yardeni’s list of “What I Am Reading” and saw this litany of downbeat headlines:
     “Blodget: History says stock performance will be crummy for ~10 years.”
     “New bear market threat: How much can you stand to lose?”

“Is there an earnings recession looming? Why one measure says yes.”
“Investors brace for stocks to fall again ahead of earnings.”

The first article (titled “Market history is calling, and it’s saying stock performance will be crappy for another 10 years,” by Henry Blodget for Business Insider, October 4) basically went back to 1900 and showed how long, flat market siestas follow big surges, but I think he got some dates wrong. The last few secular bull markets lasted an average 18 years, implying that we may have 10-12 good years ahead of us.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The second article comes from the Los Angeles Times (“New Bear Market Threat Forces the Issue: How Much Can You Stand to Lose?” by Tom Petruno, October 3). The article opens by asking, “Game over? The turmoil that has racked financial markets for the last two months has stoked fears that stocks’ six-year-long bull run has ended – and with it, hopes for a continuing economic recovery.” However, the economy is far from a recession (+3.9% GDP), while the market is slowly recovering, not falling deeper.
The third article came from CNBC (“The next worry for stocks: An earnings recession?” by Alex Rosenberg, updated on October 7 to reflect the “tough start to earnings season”). This article posits that disappointing numbers from some major companies will increase fear of an “earnings recession.” Fair enough, but that’s like predicting the results of a football game from the first two plays from scrimmage.
The fourth and final article came from Reuters (“Investors Brace for Stocks to Fall Again Ahead of Earnings,” by David Randall, October 3), which begins, “The global market volatility of the past month that sent U.S. stocks to their worst quarter in four years shows no signs of letting up just because the calendar turned to October.” But that didn’t turn out to be true. The S&P 500 rose on six of the first seven trading days of October, and it rose in a fairly straight line, with less volatility than previous weeks.
In addition, I just received the October 2015 edition of Fortune, with this seasonally-downbeat “trick or treat” headline: “Are you Ready for the Next Bear Market?” (Due to the time lag of magazines, this article was actually written before the August 24-25 “flash crash”). Bad news sells, so they opened with this “déjà vu all over again” nightmare vision: “You promised yourself you would never go through another 2008…”
Time for a Reality Check on Earnings
Let’s look at the reality of earnings. Third-quarter earnings may decline a bit, but that’s mostly because they will be compared with the third quarter of 2014, when WTI crude oil prices averaged $97.88 per barrel vs. $46.52 last quarter. As a result, earnings in the energy sector are expected to fall 65% in 3Q’15 vs. 3Q’14. Overall earnings of the S&P 500 are expected to come in about 5% below 3Q’14, according to FactSet;, but if you subtract the energy sector, earnings in the rest of the S&P 500 are expected to rise 2%.
On CNBC September 29, Wharton School Professor Jeremy Siegel admitted the likelihood of an “earnings recession” this quarter, but he went on to explain that when energy company earnings begin to stabilize, the drag on overall earnings will evaporate. He thinks that by the first quarter of next year the earnings recession will be over and S&P earnings will be growing again. For all of 2016 he says earnings growth of 8% is achievable. That is why he sees a full recovery followed by new market highs within 12 months.

In addition, Barron’s analyst Jack Hough adds (in “Spooky Outlook for Q3 Earnings,” October 12) that:

“There’s also an excellent chance that S&P 500 earnings will show a drop of less than 5% for the third quarter. Companies beat gloomy predictions during the first two quarters of this year. And while the dollar is up significantly from its value a year ago against a basket of key currencies, it has remained about flat since the beginning of the third quarter. Earnings forecasts that anticipated a further rise cutting into industrial profits could now prove conservative. Bank of America Merrill Lynch is predicting that overall reported earnings for the quarter will come in 3% ahead of estimates.”
Another reality is sagging sentiment (which I chronicled in detail last week, including the lowest Investors Intelligence Bull/Bear ratio since March 2009). According to Reuters on October 3, Bank of America Merrill Lynch data shows that investors took $22 billion out of U.S. equity funds in the third quarter, putting most of that money (a record $17 billion) into low-yielding Treasury funds. Perhaps investors can be forgiven for making a hasty exit since Treasuries are up (slightly) this year, while the S&P 500 is down slightly (off 2.1% as of last Friday), but these neo-bears may regret their timing, since the S&P is up 8% from its lows.
Bespoke Investment Group reported last Friday (in “Breadth Showing Underlying Strength Again”), that 59% of the stocks in the S&P 500 were trading above their 50-day moving average, “the highest reading since June.”
Morgan Stanley’s “On the Markets” report for October 2015 concludes that “this cycle has further to go.” Their current 12-month target for the S&P 500 is 2,200, or 14.6% above its September 30 close. That may not sound very impressive, but it certainly beats a mostly-defensive position in cash or Treasury bonds.

In all likelihood the major “crash” of 2015 already took place – on August 24 & 25, with a major retest on September 28-29. Warnings of a crash in October may be an overreaction to what has already happened.

This Day in Market History
All content in “Market History” represents the opinion of Gary Alexander.
Is October 13 a Lucky Day – or Not?
By Gary Alexander
Tuesday, October 13, 1987 was the calm before the storm, with a 37 point (+1.5%) gain in the DJIA, but Wednesday the 14th was the opening shot of the Crash of 1987.   The DJIA fell by a then-record 95.46 points (-3.8%) and nearly 800 points (-30.7%) in just four trading days. People talk a lot about Black Monday, October 19, but what happened on the previous Wednesday to launch such a rapid descent?
The Federal Reserve wrote (in “A Brief History of the 1987 Stock Market Crash…” published in 2007):
“Two events Wednesday morning have been pointed to as precipitating a decline in the stock market that continued for the rest of the week. First, news organizations reported that the Ways and Means Committee of the U.S. House of Representatives had filed legislation to eliminate tax benefits associated with financing mergers. Stocks’ values were reassessed as investors reduced the odds that certain companies would be take-over targets. Second, the Commerce Department’s announcement of the trade deficit for August was notably above expectations. On this news, the dollar declined and expectations that the Federal Reserve would tighten policy increased. Interest rates rose, putting further downward pressure on equity prices.”

To the shock of most investors, there was no late-1980s recession, and the market reached new highs in under two years – until panic struck again on Friday, October 13, 1989. With about two hours left in the trading day, United Air Lines (UAL) threatened to delay some of its bond payments due to a breakdown in negotiations on a leveraged buyout. The DJIA closed down 190.58 points, the second worst daily point drop on the DJIA to that date. On that Friday, I was staff editor of two financial newsletters. We had to quickly record telephone hotlines and publish weekend Flash Alerts to calm frazzled nerves. Investors feared another Black Monday, but the Dow rose 88 points on Monday, although UAL shares fell further.
On Monday, October 13, 2008, the DJIA scored its biggest daily point gain ever, up 963 points (+11%). Before that, however, the DJIA had fallen triple-digits (128 points or more) in each of the previous seven sessions. Two days later, the DJIA suffered its second-worst daily point decline, down 733 points (-8%).
New York’s 2008 crash was child’s play compared to Iceland’s market collapse. Their stock market was closed October 9, 10, and 13. When it opened on October 14, the OMX Iceland 15 market index fell 77% in one trading day, reflecting the fact that the value of Iceland’s three big banks (Kaupthing, Landsbankj, and Glitnir), which formed 73.2% of the 15-stock index, had been reset to…zero. Relative to the size of its economy, Iceland’s banking collapse was the worst one-day decline in any country in recorded history.
Also on October 13, 2008 – hidden among these dismal market results – Paul Krugman won the 2008 Nobel Prize in Economics and the Federal Reserve approved the merger of Wells Fargo and Wachovia.
Happy 240th Birthday to the U.S. Navy
(and to Texas, California, Kodak, & the White House)
The U.S. Navy was born on October 13, 1775, when the Continental Congress authorized construction and administration of the first American naval force, consisting of just seven ships. Championed by John Adams in the face of stiff opposition, the fleet quickly grew to a formidable force by the War of 1812.
On October 13, 1792, the cornerstone of a new Presidential mansion on the Potomac was laid. President George Washington did not occupy that home, but every President since John Adams did. At first, it was called “The Presidential Palace,” then “The Executive Mansion.” The British burned it down in 1814, but it was rebuilt for President James Monroe in 1817. (The term “White House” was coined the next year.)

The two biggest states (by population) were born on this day. The State of Texas was born October 13,1845, when it ratified its state constitution. Texas soon joined the Union as the 28th State. The second biggest state (by square miles), California, signed its state charter in Monterey on October 13, 1849.

On October 14, 1884, George Eastman (1854-1932) was granted patents for paper-strip photographic film and formed the Eastman Dry Plate and Film Company (later Eastman Kodak). By the 1920s, Kodak had a virtual monopoly on the making and selling of cameras, film, and processing. Eastman was also one of the first CEOs to introduce profit sharing as a “wage dividend” (bonus), which the company paid even in the 1930s (except 1934). By 1924, at age 70, George Eastman was worth $150 million (about $3 billion in today’s money). He gave over half of his wealth away, including endowments for the University of Rochester (including the Eastman School of Music), and the Massachusetts Institute of Technology.
On October 14, 1899, the Literary Digest declared that “the ordinary horseless carriage is at present a luxury for the wealthy; and although its price will probably fall in the future, it will never, of course, come into common use as a bicycle.” The automobile is still with us. The Literary Digest is not. It died in 1938 after making another clueless prediction – that Alf Landon would beat FDR in the 1936 election.
Sector Spotlight
All content of “Sector Spotlight” represents the opinion of Jason Bodner.
Three “Unloved” Sectors are Leading This Recovery
By Jason Bodner
The universe is a very vast place. We have difficulty comprehending the scale of it from earth, but it turns out that everything you can see – all the planets, stars, galaxies, and nebulae – are just a tiny fraction of what is out there, and all visible matter accounts for only 4.9% of the total mass-energy of the universe. Dark matter is roughly 25% while dark energy is roughly 70%. Neither dark matter nor dark energy can be seen or detected, but something we can’t see or fully explain is responsible for some pretty fundamental properties of our environment, such as the expansion of the universe.
In the stock market, there are often shifts and trends which become visible over time, but what is causing the movement may seem initially as mysterious as dark energy. In the market of late, the October rally has been propelled by the weakest sectors of recent months – namely, Energy, Materials, and Industrials.
Source: Bloomberg
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Can this Energy-Led Recovery Continue?
An energy-led rally with companies that have recently been on the ropes certainly makes sense on some level. Bargain-hunting and short-covering seem to be the likely scenarios sparking this up-trend. Yet, as the chief commodity largely responsible for the sector’s earnings – namely, oil – has fallen well over 50% from its highs a little over a year ago, it seems reasonable to expect that their earnings outlook is not rosy.
The margins for oil and gas companies are under pressure with the price of the underlying commodity depressed from prior levels and global demand trending lower. Debt levels are static, and there is a real fear of these companies’ inability to sustain the status quo of their businesses. This fear has played out for over a year now, since September of 2014. Yet here we are with the S&P500 Energy index posting a 7.77% gain for the week and +10.79% in October (month to date).
Even with this eye-catching performance, the index is still down 22.7% for the last 12 months. I’m not going to say that I think this bounce in the energy sector will be short lived or isn’t “real,” but I will say that for the sector to emerge as a leader, we would want to see the price growth accompanied by growing revenues and earnings. This doesn’t necessarily look like it will be the case for the foreseeable future.
There is, however, one very real positive that is possible. The market’s elevated volatility has been locked in with the price of crude oil. If the physical commodity’s price volatility dies down and settles into a range, this would be great for the market trying to catch its stride.
Looking at the six-month chart, we can clearly see the sector is trying to break out of a downtrend:
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
It is interesting to note that while the market seemed cheery this past week, the S&P 500 Health Care Index posted a meager 25 basis point gain for the same period. This was largely due to Tuesday’s 1-day drop of -2.33%. The sector has been under pressure for a while with a 3-month change of -10.02%, a 6-month change of -8.25%, and a 9-month change of -2.43%. Still, for 12 months the sector is +7.21%. (Note: All of the sector calculations in “Sector Spotlight” are based on Bloomberg historical data)
With earnings season upon us, we will soon see if this typically stable sector maintains the strong earnings pace from prior quarters. Guidance will also be an interesting “tell” for the coming weeks.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The strongest sector of the past 12 months, by far, is the S&P 500 Consumer Discretionary Index, up 16.25%, or more than twice the second-place sector. The sector has posted positive returns for 3, 6, 9, and 12 months and is +3.75% month-to-date (vs. -2.14% for the S&P 500). We will see if fears of a China slowdown affect actual performance in earnings over the next few sessions. With S&P 500 earnings slowing for two consecutive quarters, I would expect to see some slowdown in growth. Looking at a 5-year chart of the index, though, it would seem natural for at least a pause in price appreciation. (Note: All of the sector calculations in “Sector Spotlight” are based on Bloomberg historical data.)
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
All too often, price shifts occur for reasons which don’t reveal themselves until way after the move has gotten underway. Getting back to Dark Matter, it was not until 1932 that Jan Oort postulated this hidden force could account for orbital velocities of stars. We still have no direct proof of the existence of dark matter or dark energy, but we know that they are there and are at least in part responsible for some of the motion and stability of the heavenly bodies. We may be struggling to find physical proof hundreds of years from now, but in that time the universe will keep on expanding. And as we look at a potential pivot point here in the equity markets, perhaps it is less important to dwell on the proof of why it is there than to notice the fact that it is indeed there. The reason for the move may not become clear for some time.
Stat of the Week
All content in this “Stat of the Week” section of Market Mail represents the opinion of Louis Navellier of Navellier & Associates, Inc.
Trade Deficit Rises 15.6% to $48.3 Billion
By Louis Navellier
On Tuesday, the Commerce Department announced that the trade deficit rose 15.6% to $48.3 billion in August, up from $41.8 billion in July and reaching a five-month high. Imports rose by 1.2% to $233.4 billion, while exports declined 2% to $185.1 billion. A 30% surge in the imports of electronic goods, like cell phones, was largely responsible for the surprising rise in imported goods. There is no doubt that the new Apple iPhone 6s was partially responsible for a surge in imports for electronic goods. On the other hand, the drop in exports, which are now at a three-year low, does not bode well for third-quarter GDP growth, so economists are now cutting their third-quarter GDP estimates due to the surging trade deficit.   Overall, exports are now down 6% vs. a year ago and are clearly being hindered by a strong U.S. dollar.

Another possible reason for the drop of exports is the ongoing global growth concerns, especially in China. Jitters regarding China and emerging market demand continue to haunt the global economic landscape. On Tuesday, Germany’s economics ministry reported that manufacturing orders declined by 1.8% in August, due to a 3.7% drop outside the euro-zone. This drop in German factory orders was truly a big surprise, since economists were looking for a 0.3% rise in August. According to Global Finance (on October 6), Ralph Solveen, an economist at Commerzbank in Frankfurt, said, “It looks like German companies are increasingly feeling the pinch from the emerging markets slowdown.” An economist at the German Federal Statistical Office said that demand outside the euro-zone “was weak across the board, especially in vehicle manufacturing.”
The “Doves” are in Control of the FOMC
On Thursday, the Federal Open Market Committee (FOMC) minutes for the mid-September meeting were released and the big surprise was that the Fed decided that it would be “prudent” to wait to hike key interest rates, even though many FOMC members thought that the weaker growth outlook for China and subsequent drop in stock prices around the world would only have a small effect on the U.S. economy.
Some FOMC members said that these global developments did not increase the likelihood that inflation would return to the Fed’s 2% target. In the end, most FOMC members (i.e., the doves) were worried that hiking rates too soon would strengthen the U.S. dollar and risk more deflation, while others (the moderates and at least one hawk) said that delaying an interest rate hike for much longer would inevitably risk an undesirable buildup of inflation. Overall, 13 of 17 FOMC members were forecasting a key interest rate hike this year, but since the FOMC minutes were announced before the disappointing September payroll report and downward revisions for July and August, a December FOMC interest rate hike remains uncertain in the wake of disappointing job growth, declining wages, and ongoing deflation fears.
Finally, I should add that former Fed Chairman Ben Bernanke appeared on CNBC’s Squawk Box last Monday (October 5) and provided some insight into how the Fed operates and how the FOMC analyzes economic data. He said that he was not sure the U.S. economy could handle four 0.25% interest rate hikes. Specifically, when discussing whether or not the Fed can raise key interest rates 1% without damage, Bernanke said, “That is not obvious, I don’t think everybody would agree to that.” Furthermore, Bernanke said that high interest rates could “kill U.S. exports with a very strong dollar.” Additionally, Bernanke said that the “mediocre” September employment report is a “negative” for the Fed’s plan to begin hiking rates in 2015.
Bernanke also said the Fed’s $4.5 trillion balance sheet was not a big issue and added that when the time comes, the FOMC will just let these debt assets (i.e., mortgage-backed and Treasury securities) mature. Frankly, I would be shocked if the Fed ever let its balance sheet shrink, since it remains a primary tool (in today’s near-zero-interest rate environment) to influence interest rates through its open market operations.


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