Stephanie Pomboy: The Fed Will Have to Reverse Course

MacroMavens President Stephanie Pomboy sees a tough economic environment ahead that will force the central bank to reverse course.

By Lawrence C. Strauss

May 24, 2014

The U.S. economy, propped up in recent years by multiple rounds of quantitative easing by the Federal Reserve, is not even close to being robust. So asserts Stephanie Pomboy, an economist who has been quite gloomy about the economic outlookoften ahead of the curve. Prior to the great recession, she correctly predicted there was trouble ahead. However, Pomboy acknowledges that, more recently, she missed the huge run-up in risk assets, including equities. These days, Pomboy, who founded the New York firm MacroMavens in 2002, is especially worried that the U.S. doesn't have enough strength for sustainable growth without another boost from the Fed. And, she says, too many investors have a false sense of security about the economic fundamentals. Two of her main investing recommendationsTreasuries and goldreflect her caution.

Barron's: Let's begin with your macro view.

Pomboy: The No. 1 thing is that investors generally have underestimated the impact that QE [quantitative easing] has had on the economy and the degree to which it has supported growth. As a consequence, they have underestimated the cost the tapering [of monthly Treasury bond purchases by the Fed] would have, and that is starting to come into focus. People will realize that the economy really has not achieved any self-sustaining momentum and that it requires continued stimulus. I liken it to a car on a flat road that has no momentum. When you take your foot off the gas, the car just stops moving. That's essentially what the Fed is doing.

Eventually, people will start to connect the dots and say, "Hey, wait a second. We had five years of unprecedented monetary and fiscal policy, and the Fed did succeed in reinflating asset prices. Household net worth increased $25 trillion from the lows of the financial crisis, and yet we haven't generated a sustainable wealth effect." Maybe this is a dark place to go, but where would we be if the Fed hadn't succeeded in inflating household balance sheets to that degree? It is scary to imagine, because if you look at a chart of nominal consumer spending, which is 70% of GDP [gross domestic product], it has continued to decelerate, even in this period of unprecedented monetary accommodation and rampant financial-asset inflation.

"I liken the economy to a car on a flat road that has no momentum. When you take your foot off the gas, the car just stops moving. That's essentially what the Fed is doing." -- Stephanie Pomboy Photo: Matt Furman for Barron's

Where do the equity markets fit into your thesis?

What happens if stock prices just stop going up at this pace, much less go down? We don't even have to talk about the latter scenario. But if stock prices just stop inflating at the rate they had been in the past couple of years, what are the odds that consumer spending grows any faster than it has? And yet, that's the expectationthat the economy can withstand the taper, growth has its own momentum, spending is going to accelerate, and employment is going to accelerate.

What kind of U.S. economic growth do you expect?

I see growth generally doing what it has done, which is to continue to gradually slow. We've had a steady decline in nominal growth, basically since 2000. So I can see the U.S. economy continuing to grow at a slower pace. If GDP growth is currently 3.7%, I could see it slowing to 3% or 2%, with nominal Treasury yields coming down along with it. And over the longer term, there is no material upside risk to Treasury yields, contrary to the popular perception that rates are going to the moon.

Where is the yield on the 10-year Treasury, currently around 2.6%, heading?

I expect to see Treasury yields trading in a range from 2% to 3%, basically how it's been for the past several years. You want to sell at 2% and buy at 3%. I wouldn't be surprised to see rates fall below 2%, as investor perceptions about the economy meet with reality and they realize that the Fed still has a lot of work to do. In the past, the prospect of the Fed pausing the taper would have been a recipe for running to risk assets. But this time, there would be such disappointment that the economy really isn't up to snuff. We will have had QE1, QE2, and QE3. So how many times is the Fed going to get it wrong before people start to say, "These guys don't know any better than the rest of us what's going on, and they certainly don't have the solution because they've done QE three times and it hasn't helped?"

Where does the housing market fit into all of this?

To me, that's really the key piece, because the impact that QE had on real estate is arguably the most effective part of this whole policy. I share a lot of the cynicism about the effectiveness of QE and whether it just expanded the wedge between the haves and the have-nots. But it clearly helped generate this recovery in real estate prices, which did lift 5.5 million households out of negative equity. That had a legitimate cash-flow impact, as these people could either sell their homes and relocate to find a job or refinance their mortgage, because suddenly their homes weren't underwater. So it had a legitimate, positive economic impact that you can quantify, to say nothing of the benefit to the financial sector. But all of that came to an end when [former Fed Chairman] Ben Bernanke just talked about the possibility of tapering last May. So a full year has gone by, and the housing market has yet to recover its footing from just the threat of tapering. Fixed-mortgage rates have come down a little bit on the back of this recent rally in U.S. Treasuries, but rates for 30-year fixed mortgages are up 70 basis points, or 0.70%, versus a year ago.

On top of that, home prices have gone up, putting affordability further and further out of reach for many people. So what we need to sustain housing from here, if anything, is lower rates, not a taper.

What else concerns you about economic growth?

One chart that really summarizes my entire view compares net worth with consumer spending. Of the $25 trillion expansion in household net worth since March 2009, $21 trillion was financial assets, and $3 trillion was real estate. So the $21 trillion helps a very small segment of the population, while the $3 trillion has a much broader impact. But it is a massively disproportionate benefit for the high end. Even though people in that group are the marginal drivers of the economy because they spend a lot more, overall consumer-spending growth has continued to slow. In the past 50 years, we have never seen household net worth increase this much without spending growth accelerating materially as well

This time, though, spending growth has decelerated, and each year it takes another step down. With asset prices still not girding spending, we need income gains. And unfortunately, employment isn't ready to take the handoff

While the latest employment figures have fueled the hope that things are returning to normal, the numbers are skewed by people holding more than one job. Jobs have increased, but hours have not. This is reflected in the gap between the household surveywhere they ask if you are employed—versus the payroll survey, which adds up each payroll.

What are some of your key concerns about consumers?

The increase in spendingpunk as it is—is almost entirely due to higher pricesnot higher demand or unit sales. Fully 90% of the increase in discretionary spending from the precrisis level is explained by inflation. In other words, people aren't spending more because they want to. They are spending more because the price of all the stuff they buy has gone uphardly a sign of consumer strength.

Haven't you been too gloomy at times over the years?

At every turn, expectations for the economy have proved to be far too sanguine, and my seemingly pessimistic view has been vindicated. The Fed has repeatedly had to lower its assessments for growth, and renew QE. So my feeling is that I've nailed the economic forecast and that, as a consequence, I was right on interest rates. What I missed was the flight to risk against a backdrop of weakening growth, and I admittedly worshipped at the altar of the fundamentals

Liquidity can only take you so far, and at some point, the fundamentals win out, as they did ultimately in 2008. You could have asked me that question in 2006 or 2007, and I would have said, "Look at what all the economic data are telling youpeople are defaulting on their mortgages, etc., and the hit is coming." And, eventually, it did. At some point, the fundamentals will be undeniable, especially at a time when the Fed is taking away liquidity by tapering.

And the Fed can't continue to taper Treasury purchases, considering that foreign purchases of Treasuries have collapsed in the past several years. We used to rely on foreign financiers to fund our borrowing, but those days are long gone. They are buying Treasuries at a rate not much above $100 billion a year, down from $800 billion 3½ years ago.

What's the implication of this?

Foreigners are buying about $10 billion a month of Treasuries. This compares with deficit financing needs for the U.S. government of roughly $40 billion a month, based on this year's deficit. So the Fed needs to pick up roughly $30 billion a month in slack. When the Fed slashed its buying to $25 billion, effective this month, it for the first time opened up a demand deficit for Treasuries. If they continue to taper, that gap will expand, and things could get bumpy in the Treasury market. Rates won't go up five basis points before the Fed would start talking about more QE.

Who is going to buy a 10-year Treasury yielding 2% when inflation in the U.S. is 2%? No profit-oriented domestic investor is going to do that. We were able to rely on foreign central banks to buy our Treasuries, because they were trying to debase their currencies to manage their exports. But that's not the case anymore. The upshot is that we are out of natural buyers of Treasuries, and that's where the Fed has been so critical. So unbeknownst to many, the reason why Treasury yields are 2.6% is in part due to the economy, but it is largely due to the fact the Fed has just been sopping up all of the surplus supply that foreigners are leaving behind.

So, what kind of investing makes sense now?

Given my thesis that the Fed is going to have to taper the taper, so to speak, it will become clear that the economy can't handle a reduction of stimulus. As a result, Treasuries should continue to rally, in part because buying long-dated Treasuries is the mechanism by which the Fed will continue the stimulus. Second, the dollar should take a hit. There is a feeling that the U.S. is the furthest along in the recovery as it unwinds its stimulus, while the central banks in Japan and Europe are just getting started.

OK, then what assets are attractive?

The easiest way to play the idea that the dollar is going to take a hit in terms of global psychology is being long gold. This brings me back to the trades that I have recommended throughout this entire postcrisis stretch: Be long Treasuries and gold, as the twin beneficiaries of continued monetary accommodation.

Could you summarize a few other investment themes?

In the U.S., the consumer discretionary sector is the most vulnerable, and those stocks have come under pressure recently, along with the retail stocks. I'd probably want to be overweight the large-cap multinational companies versus the small-caps, because when you have a slowdown in growth, you want to stay with the companies that have the economies of scale. And in this environment, it would be good to have access to global consumers, rather than having all your eggs in the U.S. consumer basket. Looking more globally, I really do think that Russia and China are interesting plays. Yes, growth has slowed in the emerging economies, but they are still expanding faster than all the developed economies are. They are unencumbered by debt, and they have a much better demographic situation than many of the developed countries do.

Thanks, Stephanie. 

Ahead of the Tape

Market Calm Doesn't Mean Smooth Sailing Ahead

By Spencer Jakab

May 26, 2014 1:33 p.m. ET


On sale at Bloomingdale's last week: Vix bathing suits.

Masters of the universe whose wives returned from the posh Lexington Avenue department store with one of the bikinis may have chuckled. On Wall Street, VIX is shorthand for the CBOE Volatility Index, or "fear gauge," derived from stock option prices. As New York's financial elite headed off to the Hamptons for the opening of the summer season Friday afternoon, the VIX hit a 14-month low of 11.45.

That raises the question of whether financial markets are overly complacent going into the summer. With geopolitical tension over Ukraine, the South China Sea and Iran, as well as Beijing grappling with a deflating property bubble, there is no shortage of potential trouble spots.

A low VIX doesn't necessarily presage a reversal, but over the past two decades, 34 of the 50 lowest readings came in either 2006 or 2007. Financial markets were about to head from roaring boom to epic bust. The terrifying period from September 2008 to March 2009, conversely, had the 63 highest VIX levels.

Junk-bond investors also are remarkably sanguine nowadays. Analyst Martin Fridson recently cited statistical analysis to characterize that market as "extremely overvalued." It has been so for a record seven months. And they have been at least "overvalued," by his reckoning, for 23 consecutive months. That is a few months shy of their longest stretch, which ended the month Lehman Brothers collapsed.

But another part of the fixed-income market may be sending a different message. Despite tapering of bond purchases by the Federal Reserve, 10-year Treasury yields have dropped by half a percentage point since the end of 2013.

Because inflation expectations are virtually unchanged since December, buyers are now locking in minuscule real returns. That could reflect anticipatory demand for a traditional haven during economic and political crises.

Returning to a holiday-shortened week, financial movers and shakers may expect many more calm weekends at their beach houses. The most successful of them have remained fully invested in risky assets lately. They would do well to remember the words of Warren Buffett, perhaps the greatest investor of all time.

"Only when the tide goes out do you discover who's been swimming naked."

05/23/2014 03:15 PM

Europe's New Status Quo

'Ukraine Is Fighting Our Battle'

By Tobias Rapp and Gerhard Spörl

From left, Anton Shekhovtsov, Timothy Snyder, Konstanty Gebert.From left, Anton Shekhovtsov, Timothy Snyder, Konstanty Gebert.

The crisis in Ukraine has ended Europe's long period of stability -- but what does that mean for its future? SPIEGEL speaks with three experts about Putin's plans for the region and why the EU needs to step up in order to survive.

Even though the battles over the future of Ukraine have shifted to the country's southeast, there are still tents on Kiev's Maidan Square. Smoke rises from the protesters' makeshift stoves, between the neon signs of Western corporations and the burned-out ruin of the trade union building

There are photos everywhere of those who died here, an action film is being shown on a large screen and a man is playing the guitar and belting out revolutionary songs. There are donation cans and flags fluttering here and there, in this odd mixture of tent city, Occupy protest camp and youth hostel.

Earlier this month, at the nearby National University of Kyiv-Mohyla Academy, American historian Timothy Snyder hosted an international conference called "Thinking Together." Intellectuals from the United States, Western Europe and Eastern Europe gave lectures and participated in small group discussions over what the events in Ukraine mean for European and the rest of the world. Their aim was to demonstrate solidarity.

The atmosphere at the conference resembled the emotionally charged Cold War-era writer meetings, where intellectuals discussed ways to escape oppression and oppose aggressors. But instead of issuing manifestos against Russian President Vladimir Putin, attendees of the Kiev conference mostly just listened.
Snyder, who switched back and forth between Ukrainian and English, was the soul of the conference, and his presence could be felt everywhere. During his opening lecture in the university's large lecture hall last Thursday, even the aisles were filled with people. Most of the attendees were young, a microcosm of the country's future.

After his lecture, the 44-year-old Yale professor signed autographs, looking clearly uncomfortable while doing so, and then joined 61-year-old Polish journalist Konstanty Gebert and 36-year-old Ukrainian political scientist Anton Shekhovtsov for a conversation with SPIEGEL at a Kiev hotel.

SPIEGEL: Mr. Snyder, two elections will take place on May 25, one in Europe and one in Ukraine. How are the two votes related?

Snyder: The Ukrainians chose the date for symbolic reasons, to show that they are determined to pursue a European course when it comes to foreign policy. But Russia has plans for both elections. They aim to disrupt the vote in Ukraine, and hopes that right-wing nationalist and populist parties will do well in the European election, weakening the standing of the European Union, leading to conflict within the union. So the two elections are more closely related to one another than many Europeans think.

Gebert: The conflicts in Ukraine are barely being mentioned in the European election campaign -- as if the election were taking place on a different planet, as if what is happening in Ukraine were an insignificant, local event. But the Ukrainian conflicts are actually a defining event for Europe, because so much depends on how we react to Putin's provocations. Something similar happened in Bosnia in 1992 -- a land grab steered from within Serbia -- but Bosnia had no strategic importance, so we calmed down again quickly. But Ukraine is different. It is of existential importance to Europe.

SPIEGEL: People want a new, democratically elected government to quickly stabilize Ukraine after the presidential election. Isn't that asking too much, Mr. Shekhovtsov?

Shekhovtsov: The current Ukraine government is also democratically legitimate, because it was elected by the parliament. Nevertheless, the presidential election is important, mainly from an international perspective, a Western perspective, because the next president will be able to apply the power of the state, which the interim president could not do.

SPIEGEL: The elected president is supposed to apply the power of the state against the separatists in Donbas?

Shekhovtsov: I believe the new president will take a more aggressive approach against the terrorists than the current government is able to. An elected president will have the necessary authority.

SPIEGEL: The prevailing impression at the moment is that the Ukrainian security forces are not operating decisively or being particularly effective.

Shekhovtsov: The Russians infiltrated our security forces, and the local police are corrupt.

SPIEGEL: The next president won't be able to change that right away.

Shekhovtsov: No, the next president won't, but he or she will build a new security apparatus and change the entire system. We must bring about this change ourselves. We cannot wait for the sanctions imposed by Europe and the United States to take effect. The EU operates very slowly, and the votes within the apparatus and in the United States are dragging on. Meanwhile, the war is already underway. Ukraine must defend itself, its sovereignty and its territorial integrity.

SPIEGEL: What do you think is happening in Donbas, a war or a civil war?

Shekhovtsov: Because Russian aggression is behind the conflict, we are waging a war, not a civil war. And although you in the West have already forgotten about it, Russia annexed Crimea.

SPIEGEL: Europe and the West have apparently come to terms with that. Crimea is no longer an issue for them.

Gebert: Ukraine also lost Crimea because the armed forces received contradictory orders. The government owes the Ukrainians an explanation for that. But perhaps the decision not to fight actually ended up being a wise one. And now there is also a legal way to take action against the annexation

Ukraine can bring an action against Russia in the European Court of Human Rights in Strasbourg. Last Monday, the court handed down a ground-breaking decision entitling Greek Cypriots to €90 million ($123 million) in compensation for non-material losses during the Turkish invasion (of 1974). The next Ukrainian government should take the same approach.

Snyder: By the way, there are people who are talking about Crimea, in particular the Crimean Tatars. This week, they are commemorating the 70th anniversary of their deportation to Central Asia under Stalin. Close to 200,000 people were crowded into trains and removed. Russians and Crimeans can leave Crimea, but the Crimean Tatars have no alternative, because Crimea is their home, the only home they have.

SPIEGEL: What motivates Putin?

Snyder: I think Putin is playing an all-or-nothing game, geopolitically speaking. He no longer cares about tolerable relations with the EU or about a solid relationship with Ukraine. Putin has opted for something else, a much larger project, to destabilize Ukraine and the EU. It's an all-or-nothing game because there is no going back, now that he has embarked on this path.

SPIEGEL: Can he win?

Snyder: There are two options now: Either he achieves his goals, or the European Union achieves political unity and ideological stringency. It would have to define itself as Russia's adversary and, most of all, develop a joint energy policy with which it could affect Putin. If the EU could do that, there would be radical consequences for Russia. Then Putin would have to fall back on China, and Russia would become China's Ukraine.

SPIEGEL: You are alluding to the possible establishment of a Eurasian union. Plans for such a union have been making the rounds at the Kremlin and within groups aligned with Putin. The project isn't being taken very seriously in the West. Is that a mistake?

Snyder: Of course. It's the ideological alternative plan to the European Union.

SPIEGEL: What are the core elements?

Snyder: The Eurasia ideologues dismiss liberal democracy as bankrupt, and as nothing but an alibi for US interests. They consider liberal democracies to be outdated. Both communists and fascists were as dismissive about democracies in the 1920s and 30s. Putin and his Eurasia ideologues consider the West to be too decadent, a postmodern approach on their part. They view European history as a sort of convenience store

They are reinterpreting European history, borrowing whatever suits their needs from Hitler, Mussolini and Stalin. Russia is a radically conservative country today. It doesn't allow its citizens to live as they please, to love whom they please and to marry whom they want. The Eurasia ideologues see the treatment of homosexuals, in particular, as a problem that divides the global world.

SPIEGEL: That strikes a chord with the conservative nationalist parties hoping for a breakthrough in the European election. What makes Putin appealing to these right-wingers?

Shekhovtsov: He shares their hatred of the European Union. Like Putin, they too worship the nation-state as a backward-looking utopia. And they respect Putin because he advocates a strong state and doesn't care what the public thinks about him abroad. They also share his hatred of America, with its equal rights for different races, along with his hatred of homosexuals.

What The Right-Wing Can Do For Putin

SPIEGEL: But what can these right-wing movements offer Putin?

Shekhovtsov: They are easy to corrupt. The European Union has to fail for the Eurasian project to prevail, but right now Russia cannot compete with the West

That's why Putin is seeking allies in the West who are opposed to the EU, on both the extreme right and the extreme left. They are tools in the struggle against the West. And the better his allies do in the European election, the better it is for him.

SPIEGEL: What makes the European Union successful is its ideals of compromise and diplomacy. In its worldview, deep-seated conflicts are part of the past.

Gebert: Wars and conflicts have dominated Europe for centuries. We look ridiculous if we refuse to condemn Putin. Just because we feel guilty about our past, we cannot allow Putin to get away with what he is doing to Ukraine. We cannot tolerate it.

SPIEGEL: The Germans are leading the diplomatic efforts in this conflict. German Chancellor Angela Merkel is in contact with Putin, the German foreign minister is meeting with the Russian foreign minister and a German diplomat is the moderator at the new round table talks. Are they doing the right thing?

Shekhovtsov: These diplomatic efforts are not particularly meaningful or efficient. Putin hasn't been forced to take anything back. Sanctions haven't forced him to give back Crimea.

SPIEGEL: The OSCE hostages were released because it was what he wanted.

Shekhovtsov: Of course. He has influence over what takes place in eastern Ukraine.

Gebert: But we have to put this in perspective: A few hostages were released while, at the same time, Russia is occupying large parts of Ukraine. This isn't a victory for diplomacy, even if former Chancellor Gerhard Schröder got involved.

SPIEGEL: The sanctions could be tougher. More pressure could be applied to Putin.

Shekhovtsov: So far, the sanctions have targeted a few oligarchs who are part of Putin's circle of friends. The oligarchs do business in Russia, but they invest in Western Europe -- they buy houses on the Côte d'Azur and in London. They laugh about the sanctions. Sanctions can only become effective if they affect large companies.

SPIEGEL: Because the United States remains oddly removed from the conflict, the German government and Brussels are virtually alone in their diplomatic efforts. Has the United States lost interest in Europe?

Snyder: For a long time, the United States and, most of all (President) Barack Obama, believed that Russia wouldn't make any moves, that Europe was extremely stable and that China was the difficult country it had to deal with. Now Putin has changed that. The United States probably isn't sufficiently involved at the moment, but the US government is interested in Europe again. This is a fundamental shift. Three things have changed internationally: The EU is being confronted with a fundamental threat for the first time, America once again values the transatlantic partnership, and Ukrainian identity has been strengthened. Anyone who thinks Putin is a strategic genius should take a look at what he's achieved. 

If he had allowed things to continue as they had, America would gradually have drifted away from Europe, (former) President Viktor Yanukovych would have continued to ruin Ukraine and the Europeans would have kept doing what they were doing.

SPIEGEL: In that case Putin is the loser in this all-or-nothing gamble.

Gebert: Putin is neither a genius nor a loser. He is an opportunist who takes advantage of an opportunity when he sees one. He takes what he wants, and he withdraws under pressure, but only under pressure. Right now, he's taken the initiative, and he isn't afraid.

Shekhovtsov: Putin isn't waging an old war with an air force and tank offensives, but a new war, one that military experts the world over will soon be studying. It is a war in which the leading power is not directly involved. The units it deploys wear no uniforms or insignia, and there are local units, the so-called village defense troops, which have modern, automatic weapons. Putin is also attacking the EU in an unconventional way. He's going to buy politicians. Take Bulgaria, for example, which Brussels views as a Trojan horse for Russia. A vast amount of money has flowed into the country, both clean and dirty. If Russia pulls out the money, Bulgaria will have serious problems. Russia also invests in Serbia, as well as other countries in the Balkans.

SPIEGEL: Aren't you making Putin out to be more important than he is?

Snyder: I think it's important for us to understand what Russia is currently capable of doing. The country has a lot of money from the sale of its natural gas. It might be a different story in 10 years, and Putin knows that. He can still exert this influence today, and in that sense his game is actually reasonable. He also isn't under the illusion that Russia could become bigger than the EU. Its economic output is only roughly comparable to that of France. But Russia can win by weakening the EU. Destroying is always easier than building. And Europe knows how difficult it was to construct this entity.

SPIEGEL: You also argue that America is once again getting closer to Europe, the EU has gotten its wakeup call and NATO is stronger than before. What do you make of the current situation?

Snyder: We have to acknowledge that Russia has altered the status quo. In my opinion, there is now only one alternative: Either the Americans and Europeans reconcile, and finally forget about their dispute over the disastrous Iraq war and set aside their differences over the Snowden affair, and the EU invests a lot of money into an energy policy based on renewable energy. Or Europeans and Americans drift apart and the EU falls apart, so that each country has to see to its own energy supply. Then Russia can continue selling oil and gas, to Europe and to China, and will become a more powerful than it is today. But we won't be getting the old status quo back.

Gebert: It isn't about Putin. It's about us. Europe has just experienced the best 25 years of its history. That's a long time, and we've been lucky. We've become accustomed to peace and prosperity. It was as if we had made it, as political scientist Francis Fukuyama wrote in 1992, to the end of history. We were lulled.

SPIEGEL: In 2003, former US Secretary of Defense Donald Rumsfeld made a distinction between old and new Europe. He described old Europe as emphasizing soft power and being weak, while the new Europe, which supported the Iraq war, consisted of the Eastern Europe NATO countries and the Baltic countries. Is this distinction returning, between a part of Europe that sees Putin as a threat and one that underestimates him?

Gebert: Yes, one could say that. But we Poles, for example, are not worried about the Ukrainians because we're so fond of them, but because we know they're fighting our battle.

SPIEGEL: Mr. Snyder, Mr. Gebert and Mr. Shekhovtsov, thank you for this interview.

Translated from the German by Christopher Sultan