Sea Change

You don’t need a weatherman
To know which way the wind blows. 

– Bob Dylan, “Subterranean Homesick Blues,” 1965 

Full fathom five thy father lies.
Of his bones are coral made.
Those are pearls that were his eyes.
Nothing of him that doth fade,
But doth suffer a sea-change
Into something rich and strange. 

– William Shakespeare, The Tempest

Did you feel the economic weather change this week? The shift was subtle, like fall tippy-toeing in after a pleasant summer to surprise us, but I think we’ll look back and say this was the moment when that last grain of sand fell onto the sandpile, triggering many profound fingers of instability in a pile that has long been close to collapse. This is the grain of sand that sets off those long chains of volatility that have been gathering for the last five years, waiting to surprise us with the suddenness and violence of the avalanche they unleash. (...)

Shakespeare coined the marvelous term sea change in his play The Tempest. Modern-day pundits are liable to apply the word to the relatively minor ebb and flow of events, but Shakespeare meant sea change as a truly transformative event, a metamorphosis of the very nature and substance of a man, by the sea.

In this week’s letter we’ll talk about the imminent arrival of a true financial sea change, the harbinger of which was some minor commentary this week about the economic climate. (...)

Getting back to portents of winter, this week saw two side comments by Federal Reserve members that put a distinct chill in the air.

The first is from William Dudley, the president of the Federal Reserve Bank of New York and a permanent voting member on the FOMC. In a speech at Rensselaer Polytechnic Institute, he pushed back on the idea that it is time to raise rates. While acknowledging the relatively positive stance of the Federal Reserve in its forecast, he said:

While I believe that the risks around this consensus forecast are reasonably well balanced, I also believe that the likelihood that growth will be substantially stronger than the point forecast is probably relatively low. [my emphasis]

He went on to cite weaker than expected consumer spending and the expectation that consumer durable purchases will be weaker in the future (by which I assume he means automobiles, which have been on a blistering, back-to-the-all-time-high pace due to supereasy credit, much of it subprime and with durations beyond five years.) He faults mortgage lenders for the substandard housing recovery, as if the last massacre of lenders was not enough to scar their collective psyche for decades.

(Sadly, he might have a point. Somewhat humorously, Ben Bernanke tells us he was turned down for a mortgage because his income is somewhat unsteady. He did not fit the “check-the-box” protocol of his local mortgage lender. I sympathize. I was turned down multiple times earlier this year before finding willing lenders who actually competed for my business. My business life does not accord with a standard check-the-box mortgage. I read about another business owner who noted that any of his 300 employees could get a mortgage, but he could not because his income was not stable enough. Go figure.)

Each of Dudley’s points was covered in long paragraphs. And then he delivered a short, throwaway line that caught my attention. He cited the growth in the exchange value of the dollar over the last few months as a reason for downside risk. Really? Go back and look at the chart above and see the relatively minor dollar moves of the past few months. Why should dollar strength show up in a list of reasons for upcoming weakness in the US economy?

The next day saw the release of the minutes of the previous month’s FOMC meeting. In the part labeled “Staff Review of the Financial Situation,” the staff mentioned “… responding in part to disappointing economic data abroad, the US dollar appreciated against most currencies over the inter-meeting period, including large appreciations against the euro, the yen, and the pound sterling.”

While there are precedents for the staff review to mention the dollar, it doesn’t happen often.(...) The strengthening dollar is clearly on the minds of the members and staff of the Federal Reserve. Hmmm…

by John Mauldin, The Big Picture | Read more: