Let’s review a couple of the minor points worth nothing...made in the latest FOMC statement  The first is about the interplay between fiscal and monetary policy. Things have changed since the beginning of the year where the Fed wanted to raise rates to make up for the fiscal stimulus which was supposed to come in the form of tax cuts and infrastructure spending. The economy is instead accelerating without those catalysts occurring. The Fed said the following in response to this change: "Several participants noted that uncertainty about the course of federal government policy, including in the areas of fiscal policy, trade, and health care, was tending to weigh down firms' spending and hiring plans. In addition, a few participants suggested that the likelihood of near-term enactment of a fiscal stimulus program had declined further or that the fiscal stimulus likely would be smaller than they previously expected."

As you can see, the Fed must alter its assessment on what is happening in Washington which is difficult to figure out, as always. The first aspect it is taking into account is businesses pulling back on investments because of fiscal policy uncertainty. This would mean that when we get certianty, the economy will accelerate. I don’t think that’s the right assessment. The economy is growing quickly. Some businesses are saying they are pulling back from major investments in surveys, but if the economic growth is already coming, then I don’t see much pent up demand. That’s doesn’t mean I don’t think there will be an improvement if tax cuts and infrastructure spending are enacted. Clearly the firms who are the biggest benneficiaries of these changes will be helped.

This might be a fine point which can’t be deciphered, but I don’t see any added benefits from certainty because politics is always uncertain. Businesses always claim they can’t foresee the changes which will occur, but that’s part of living in America. There’s always the possibility a new party wins control and reverses everything the last party did. The one benefit which businesses are getting is the lifting of the regulatory burdens. It’s tough to determine the size of the benefit, but this action will allow businesses to proceed with ventures. This lifting of regulatory burdens runs counter to the Fed’s claim that businesses are tied down by uncertainty. That’s an adendum to the main point which is the strong economic reports don’t lead me to believe businesses are hesitating. For example, if retail spending is strong, firms will respond to the demand regardless of potential changes in the tax code.

The second minor point from the FOMC is the Fed’s concern about stocks being overvalued. The Fed sees the stats we see. The market hasn’t had any volatility this year. The Fed has expressed worry about this in the past. It made the following statement on this topic: "Participants also considered equity valuations in their discussion of financial stability. A couple of participants noted that favorable macroeconomic factors provided backing for current equity valuations; in addition, as recent equity price increases did not seem to stem importantly from greater use of leverage by investors, these increases might not pose appreciable risks to financial stability." As you can see, the Fed has eased its worry about valuations. The Fed has a terrible track record when forecasting stock prices which is why I wouldn’t want the Fed to purposely push stocks lower to avoid a crash. The Fed is now seeing the economic activity improving which is what the market correctly forecasted earlier in the year by rallying.

The Fed mentioned the lack of a greater use of leverage. I guess they missed the record short VIX position. That position isn’t pushing stocks up, but it does add risk to the system. Looking at the debt market, there has been a movement to push leverage further down the line. As you can see from the chart below, the U.S. leveraged loan maturity wall has been delayed because of the great credit conditions. The debt maturing in 2018, 2019, 2020, and 2021 has declined, while the debt maturing in 2022, 2023, 2024, and 2025 has moved up. This kicking the can down the road delays the inevitable crash as when the economy weakens, firms will have a tougher time refinancing and a tougher time using profits to pay back the debt. There isn’t any risk in the next 3 years, but if there is a recession which is elongated, it could lead to massive bankruptcies. The economy is helped by the employment these risky firms provide, meaning the economy and the stock market are leveraged.

While the Fed is less concerned about valuations now, there was a part which might worry investors. The Fed said, “According to one view, the easing of financial conditions meant that the economic effects of the Committee's actions in gradually removing policy accommodation had been largely offset by other factors influencing financial markets, and that a tighter monetary policy than otherwise was warranted.” That must scare some of the bulls because not only does the Fed not have the market’s back anymore, but it is considering purposely tanking the market by being overly hawkish. This is only one member saying this, but there was also one dovish member in Kashkari a few months ago and his camp has grown. If this ‘forced correction’ camp grows, I think the market will selloff in anticipation of any policy action.

Conclusion

The Fed is managing the fiscal policy uncertainty and potential stock market bubble. By managing it, I mean the Fed is watching the situation and not doing anything. The Fed shouldn’t raise rates to stop a bubble in stocks because that would tank the economy. Tanking the economy to save it is a poor plan. The end result is the same. I would argue, the Fed should normalize rates to prevent a future bubble. Notice the difference between normalize and being overly hawkish. If the Fed didn’t want stocks to go up this high, it shouldn’t have done QE. With President Trump’s policies, the Fed is afraid deregulation will increase systematic risk. It ignores its own creation of the housing bubble by keeping rates too low and encouraging people to get variable rate mortgages. I think deregulation will improve productivity growth; it’s a great idea.