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The Fed Is Stuck

The Federal Reserve headquarters in Washington, DC.
The Federal Reserve headquarters in Washington, DC.

We got very little from the Fed announcement, but what do you expect? They're stuck.

Hope you were all listening to David Faber's excellent interview with Jeff Gundlach of DoubleLine Capital earlier Wednesday Gundlach was lucent on the Fed’s “problem” with inflation:

1) in the old days, the Fed could mount a pre-emptive strike against inflation; there is no way that can happen now. There is no way the Fed will raise rates as long as inflation is more "theoretical" than actual.

The reason: the average rate on Treasurys was 6 percent a few years ago, it is now 2.5 percent. If rates were to rise to 6.5 percent, there would be trillions of dollars of new debt added to the $15 trillion debt level. The Fed cannot afford to let that happen.

2) because of that concern, the threshold for action on inflation is now higher. Gundlach believes the Fed will not act unless CPI is over 4 percent. It is already above their price of 2 percent, but the Fed is insisting that rise is "temporary"

What about the big rise in necessities like milk and gasoline? Isn't that inflation? Gundlach says it is, but there is no inflation in the two most important indicators: wages and housing. That’s giving the Fed cover.

3) there may be one more Treasury bond rally, but even if there is one, you make very little money.

How do you get out of this? The dream scenario that would balance the budget in about 12 years: Get nominal GDP growth of 6 to 7 percent, with a freeze on U.S. government spending, while keeping rates low.

Good luck with that.

And your new market leader is: real estate investment trusts (REITs). That's right: the MSCI REIT Index, a basket of REITs, is at a 4-year high. REITs are commercial real estate companies that own and invest in real estate on behalf of their investors.

What's going on? REITs have been the most direct beneficiaries of the Fed's policy of low interest rates. They have been able to refinance their debt at considerably lower rates. Relatively high dividend payouts of two to four percent also attract the dividend crowd.

But it's the improving fundamentals that are the key:

1) apartment rentals have been exceptionally strong, with rising rates and occupancy

2) high quality malls are recovering, with new retailers replacing older ones

3) business travel has improved hotel occupancy rates, though leisure travel is still lagging

The one area still lagging: suburban office space. There's just too much of it.

And your new laggard is: big-cap financials. Ever since earnings season began, all the big names have lagged and are doing so again: Morgan Stanley , Goldman Sachs , Citi , JPMorgan .

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