Does Your Forecast Consider The Punchbowl?

Here is David Merkel:

Unless revenue growth kicks in, that means the profit margin, already at record highs, will soar to an astounding record. But won’t revenue growth begin again? That’s hard to say, but if revenue growth starts in earnest, the Fed will start removing policy accommodation, because ban lending will be perking up. At that point, it is anyone’s guess as to what will happen.

In other words, never forget that the central bank moves last.

Let’s say you have a forecast for what the economy/stock market will do in the medium term. Your forecast almost certainly assumes current fed policy stays in place, which, depending who you ask is somewhere between mildly accommodative and crazy-time loose. Bernanke is on my TV right now warning against prematurely tightening, so your assumption is probably good, right?

David, of course, is smarter than that; he knows that fed accommodation is a function of the consensus of a relatively small group of very fallible humans. Right now, for example, the market thinks fed accommodation is really important and that the fed is doing a good job of laying out the punchbowl. Rewind a few years and the market had a similar hope but the opposite evaluation.

Now David happens to not like the current monetary policy stance but his view (like that of anyone that thinks about this for a while) is rather complex. My view is that I believe some version of EMH and believe that aggregate stock market value is something of a proxy for the general economy (stock market goes up, economy is good). This means the market represents the most intelligent possible evaluation of monetary policy and it’s thumbs up right now.

But how might policy change when the recovery picks up? This is THE critical macro question and any analysis that ignores it should be thrown in the trash.

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