What Spooked The Fed?

In the aftermath of last week’s FOMC “dovish hold” disappointment, it is not only the Fed that has seen its credibility crushed; so have plain-vanilla tenured economists and Wall Street strategists. Recall that it was on August 13, one month before last week’s FOMC meeting, when 82% of economists said the Fed would hike in September.


Post-mortem: more than four out of five economisseds were, as always, wrong. Hardly surprising: after all, when voodoo art pretends to be science, this is precisely the outcome one gets.

But while there is no surprise in everyone being wrong (because quite simply nobody realized that the only thing is what Goldman wants), one question remains: “what does the Fed know that we don’t.”

Of course, one has to clarify what “we” means, because Zero Hedge readers know precisely what the Fed knows – it knows that a recession is coming if not already here, as we won’t tire of showing week after week.

Here are some examples of what the Fed (if less than 20% of economists) “knows“:

1) Business Inventories-to-Sales are at recesssion-inducing levels…


1a) Sidenote 1 – Wholesale Inventories relative to sales have NEVER been higher


1b) Sidenote 2 – here is why that is a problem

2) Industrial Production is rolling over into recession territory


2a) Sidenote – as Empire Fed confirmed this morning for August – inventories are collapsing (and along with that Q3 GDP)


3) Retail Sales is not supportive of anything but a looming recession…


And finally,

4) The last 6 times Auto Assemblies collapsed at this rate, the US was in recession…


* * *

But for those who are unable to form an independent though and would rather ignore reality unwinding before their eyes, instead demanding an “authoritative” voice to crush their cognitive bias, here is Ray Dalio, head of the world’s biggest hedge fund Bridgewater, who explains what the recent 4% drop of his All Weather risk-parity fund means.

This is what he said: “different risk parity managers structure their portfolios somewhat differently to achieve balance, so we can’t comment on them all. But we can show you how this wealth effect has worked by showing you how our diversified portfolio mix (which simply represents a well-diversified portfolio of assets) would have led economic growth, which is shown in the below two charts, one of which goes back to 1950 and the other which goes back to 1915. These charts show how the excess returns (the returns of the portfolio over the return of the cash interest rate) led economic growth relative to potential (i.e., estimated economic capacity)… If a well-diversified mix of assets underperforms cash, there will be a negative wealth effect and negative incentives to invest in economic activity, which will be bad for the economy. The Federal Reserve and other central banks would be well-served to pay attention to this relationship to make sure that this doesn’t happen for long and/or happen too severely. The chart speaks for itself.

The chart in question:

And just in case it “does not speak for itself“, here is Ice Farm Capital’s Michael Green explaining what is says: “The recent weak performance of All Weather would suggest global growth six months from now will be running nearly 2% below its already reduced potential.

In other words, while the rest of the levered-beta 2 and 20 chasers formerly known as “hedge funds” recently accused risk parity of blowing up their August returns (September is not shaping up much better) the biggest risk-parity fund in the world also found a scapegoat: the global economy, which according to Dalio, is the reason for All Weather’s dramatic August slump.

But while blaming the amorphous economy is a rather weak argument, Dalio already has a far more tangible scapegoat ready: the Fed itself, who as the Bridgewater letter cautions “would be well-served to pay attention” to the hedge fund’s sudden P&L drop. Because as Dalio goes, so goes the economy.

For now, however, the message is far simpler: absent far more easing, what the charts above signal is that the US economy is about to slam head-on into an economic recession… or rather depression, one which some would add, is only inevitable due to some 40 years of Fed easing starting with Greenspan’s great moderation, and continuing through three sequential credit-fuelled bubbles which merely delayed the inevitable “mean reversion” moment