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Can More Fed Twisting Actually Help?

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Twist is centered on the theory that lowering interest rates will get American consumers and businesses to expand borrowing and spending. But how low do we have to go?

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Fundamental honesty is the keystone of business decisions.
--Harvey S. Firestone

US Economics and the Stock Market

Is there correlation, non-correlation, or is it simply emotion driving the tape? Considering the economic news released last week the US, equity markets played quite the tune, akin to a punk rock band: No rhyme or reason in its beat. Of the five trading days the Dow Jones Industrial Average's (^DJI) range (top to bottom) was nearly 200 points in four of the five days. The last two had the strongest three-day rally of the year and was the first time there has been back-to-back 200 point gains (Friday was close at 188) since 2008.

Monday began the week with continued news about the Libor scandal. Tuesday arrived by threatening the PIIGS nations with a 7.5% interest rate out of Spain. This pummeled those equity markets, with Greece dropping 7% in a single day. By Wednesday we heard from Mario Draghi, the president of the ECB succeeding Jean-Claude Trichet, as he stated the ECB will do "whatever it takes to preserve the Euro." This seemed to plug the dam for the time being. From there it was off to the races.

Much like a magician's technique of misdirection, the lackluster US GDP news of 1.5% growth seemed to disappear in a puff of smoke. But why? The thought on the Street has become "bad is good." With the so-called "leak" from the Federal Reserve to the Wall Street Journal of further Operation Twist action, negatives soon became positives. The question now becomes: Can more Twist actually help?

Twist is centered on the theory of lowering interest rates (the 10-year yield) in the hopes of getting American consumers and businesses to expand via borrowing and spending. But here's the joke: How low do we need to get interest rates to increase confidence? Or maybe, just maybe, it's not cause and effect like history of past recessions has shown us. As seen below, the 10-year is at new lows now (~1.5%).

us-10-year-yield-chart

Assuming the theory is correct, we should be seeing expansion in GDP (spending). Three percent, 2%, followed by 1.5% doesn't seem to be having such an effect.

us-gdp-chart

The next theory in the camp of lower rates is that it will take time for confidence to rise and show itself in expansion. If this happens to be factual we should look at confidence. The following chart illustrates that business confidence has now dropped back below 50 for the first time since the 2008 "Great Recession."

business-confidence-chart

Presuming business confidence is directly proportional to hiring, and hiring is directly proportional to consumer confidence, maybe we ought to look at employment. Again illustrated below, employment (non-farm payrolls) have done nothing but slide since 2012 began.

nonfarm-payrolls-chart

Albeit a three-day 400+ point rally, I again ask: Where's the beef? As market technicians, we must pay attention to these types of rallies, especially with increasing volume. On the other hand, it is very difficult to gain any confidence in this market with the underlying foundation still not ready to support such action. With the Fed meeting this week, I expect continued volatility, but as they say: Buyers beware!

I hoped this helped and finds you well.

Editor's Note: Read more at Tesseract Asset Management.

Twitter: @TAM_News
No positions in stocks mentioned.

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