Fed Minutes: Are They A Hodgepodge?

Fed minutes - Some have commented that the Fed Minutes is a mishmash of various discussions had by investors, members of the media, and economists. That’s probably a harsh way to put it because you can’t expect the Fed to not talk about the news of the day such as trade wars and the end of the effects from the fiscal stimulus.

The Fed Minutes look bad because they are old. The Minutes, which were released Wednesday, are from the discussions on July 31st and August 1st.

You can’t expect the Fed to be ahead of the curve in discussions from a few weeks ago.

Ultimately, I don’t care about the Fed’s analysis of the economy in terms of its forecasting ability because I do my own research. I only care about the Fed’s thoughts in terms of what it means for monetary policy. Their discussions also give me a great platform to discuss the latest data in the context of what it means for monetary policy.

Fed Minutes - Threats To Strong Economy Discussed: High Stock Prices

The Fed Minutes was all about risks the economy faces because the economy is as perfect as it can get right now as inflation is modest and growth is strong. There are reasons to worry about the second half, but if you look at the first half, there are more risks of things that can go wrong than things that can go right because almost everything went right.

The Fed worried about “elevated” stock valuations and “easy” corporate borrowing conditions. I don’t see why stock prices going up and easy borrowing conditions are bad. In my opinion, that’s like worrying about too much of a good thing.

Stocks will go down and corporations will default when there is a recession. This happens regardless of how high they got and how easy borrowing was in the previous expansion.

Stocks didn’t get that high in the last cycle as it was short, but stocks still fell over 50% during the recession.

Fed Minutes - Historical References

Furthermore, good events don’t beget bad ones. For example, if the economy grows for a long time and does well, it doesn’t mean a bad recession is coming.

The expansion in the 1990s was the longest since the mid-1800s, yet the recession in the early 2000s was modest.

It’s easy to think of the Nasdaq crash, but the economy never got that weak.

It’s worth mentioning that stocks aren’t that expensive when looking at forward multiples as the expected $175 in earnings in 2019 gives the S&P 500 a forward PE of 16.35. The Shiller PE is at 32.89 and the price to sales ratio is at a record.

It’s not fair to say valuations aren’t too high unless you expect earnings to miss estimates by a wide margin.

Fed Minutes - Emerging Market Weakness

The other risks the Fed mentioned were emerging markets, housing, the flattening yield curve, and a possible trade war. "Wide-ranging tariff increases would also reduce the purchasing power of U.S. households. Further negative effects in such a scenario could include reductions in productivity and disruptions of supply chains.

Other downside risks cited included the possibility of a significant weakening in the housing sector, a sharp increase in oil prices, or a severe slowdown in [emerging market economies]".

It’s tough to say if emerging market weakness will hurt the economy because emerging markets have already been weak this year while the U.S. economy has been strong. As you can see from the chart below, this correction in emerging markets is unlike the previous two in 2011 and 2015 because the S&P 500 has been increasing.

(Click on image to enlarge)

It’s notable that I think the emerging market weakness is a combination of individual countries doing poorly rather than contagion. That’s important to point out because it means politics in Brazil and Turkey have been more influential than the rising dollar and U.S. rate hikes.

This means there isn’t a wave that will bring down strong economies like America. Ultimately, the Fed has shown it only gives lip service to emerging markets because it has continued to raise rates despite their weakness.

The only way I will be convinced the Fed cares about emerging markets is if specifically stops raising rates because of an issue in these countries. That could happen if there is contagion, but until then they will be ignored.

Fed Minutes - Housing Weakness

It’s weird to see high oil prices on this list because oil prices have been stable for a few months. Obviously, it is a risk, but it’s a low probability one. Housing market weakness is a real risk because the latest data is disconcerting. The most recent data on the housing market came out on Wednesday.

The July existing home sales report was disappointing as it came in at a seasonally adjusted annual run rate of 5.34 million which was below the consensus for 5.42 million and last month’s report of 5.38 million. It was below the lowest estimate for 5.39 million.

Existing home sales fell 0.7% month over month and 1.5% year over year. The prior month saw declines of 0.6% and 2.2% respectively.

Existing homes sales have been down 4 straight months and are at a 2.5 year low. Condo resales were at a 590,000 rate which is a decline of 4.8% month over month and 3.3% year over year. Single-family home sales declined 0.2% month over month.

All regions saw weakness year after year; the west was the only region which saw gains on a month over month basis (4.4%).

Supply and rising rates are a problem for housing. Supply was down 0.5%. At the current sales rate, there is a 4.3 month supply of houses on the market. Month over month prices fell 1.5% to $269,600. They were up 4.5% year over year.

​Fed Minutes - Conclusion

There is so much to discuss regarding the Fed’s Minutes that I’ll need to finish reviewing the risk factors the Fed sees in my next article. I’ll also include the market’s reaction and the expectations about future rate hikes.

Finally, I’ll review the discussion about where the neutral rate is. That is about to be a major discussion in 2019 as some think it will reach that rate soon.