By Alan Hall, guest columnist
For more than two decades, Elliott Wave International has been tracking the relationship between interest rates set by the marketplace and interest rates set by the U.S. Federal Reserve. The link we identified — that the market leads and the Fed follows, not the reverse — continues to hold, as we'll show in a moment. This observation supports the idea that mass social mood is an important influence on interest rates and that, by extension, social mood also strongly influences the Fed.
Now there has emerged a fascinating, more direct way to observe mood's influence on the Federal Reserve.
Let's begin with an update of EWI's 2007 chart showing that the market leads the Fed. The continuous line is the three-month U.S. T-Bill yield set by investors and the dashed line is the Federal Funds Target Rate set by the Fed.
Which Moves First — the Market or the Fed?
Figures 1 and 2 both show that the T-bill market moves first. The Fed's interest rate follows the changes in T-bill rates.
Chapter 19 of The Wave Principle of Human Social Behavior (1999) describes the result: "A socionomist monitoring the T-bill rate can predict with fair accuracy what the Fed will do. No one monitoring the Fed's decisions can predict what T-bill rates will do."
What about dramatic periods of double-digit rates? Figure 3 plots T-bill rates and the Effective Federal Funds Rate (a weighted average of the Fed Funds rate across all banking transactions) during the early 1980s. T-bill rates (lower line) peaked four times in 1980-1982. Each of those peaks occurred a month or more before subsequent, reactive peaks in the Federal Funds rate (upper line). Yet Paul Volcker, the Fed Chairman at the time, is widely credited with ending stagflation by raising the Federal Funds Rate to record levels.
For an in-depth analysis of the socionomic influences on today's interest rates as well as EWI's forecast for a long-term reversal in rates, see the June 6 Elliott Wave Theorist/Financial Forecast Special Report. (Theorist and Financial Forecast subscribers: Log in at my.elliottwave.com; non-subscribers call Customer Service for prices.)
The FOMC Laughter Index
Since 1974, the Federal Open Market Committee (FOMC) — a group within the Federal Reserve that oversees the Fed's buying and selling of United States Treasury securities — has produced five-year-delayed transcripts of their meetings.1 Beginning in November 1976, the transcripts include "[Laughter]" notations. As far as we can tell, The Daily Stag Hunt website in January 2012 was the first to publish a chart showing a portion of the laughter data.2 We have expanded on the idea, charting every "[Laughter]" notation and plotting them against the Dow to assess how they align with social mood (see Figure 4).
The first significant laughter occurred in 1979-1980, soon after Paul Volcker became Federal Reserve Chairman. Those chuckles immediately gave way to the longest dour spell in the data — a 17-month span indicated at the bottom of the chart — that coincided with the interest rate extremes shown in Figure 3. This period includes the final low of the triple bottom in stocks of 1974/1980/1982.
A burst of laughter accompanied Alan Greenspan's August 11, 1987, appointment as Fed chairman. The Maestro arrived just two weeks before the August 25 major peak in the stock market; the subsequent negative social mood drove the September-October stock market crash and cast a pall on the Fed's meetings.
February 1991 brings the only record of the FOMC committee "hooting" with laughter. At first glance, this seems strange, as the economy remained mired in a recession at the time. The hooting therefore had no rational basis, and anyone trying to predict the Fed's mood using the conventional event-driven model would have forecast a somber meeting. But in fact, a Primary-degree period of negative social mood — labeled Wave 4 in the chart — had just ended, and a large-degree positive trend in social mood was under way. The Dow had already begun rising sharply toward new all-time highs in wave (1) of 5 of V. The Fed was simply expressing society's ebullience. Here is an excerpt from the meeting's transcript:
MR. HOSKINS. You're probably all waiting for my stainless steel strip index, but I'm not going to give it to you because I've latched onto a new one: the Smuckers Index! I had a chance to talk with Paul Smucker, an elderly gentleman who has been through many business cycles and he told me that apple butter sales remain relatively soft and that's a good sign because during deep recessions apple butter sales soar. [Laughter] So, I'll be reporting to you on apple butter.
CHAIRMAN GREENSPAN. It sounds to me as though business is in a jam! [Laughter/hoots]3
The Fed's mirth trended higher for the next 15 years as social mood shot toward a historic positive extreme. In June 1999, seven months before the 2000 peak in the Dow, Alan Greenspan made remarks that showed he assumed — naturally but wrongly — that the prevailing optimism would continue. In fact, the extreme optimism, especially regarding technology, was a socionomic signal that a reversal was nigh. His comments book-ended a joke about his own age, prompting laughter from his fellow committee members:
CHAIRMAN GREENSPAN. We have no evidence at this stage of which I am aware, however, that indicates the acceleration in productivity has ended. All of our experience and courses in Econometrics 101 induce a visceral antipathy to such persistence in productivity gains, especially for me since I have the oldest gut in this room. [Laughter] What is increasingly evident is that something seems to be happening that none of us has ever witnessed before—perhaps a once-in-a-century structural shift in how goods and services are produced. People in the front lines of business operations, such as Jack Welch of GE and Lou Gerstner of IBM, say this is a true revolution. They have seen nothing like this in their experience. And I venture to say that if we get on the phone with a number of business people who have been around a long time, we are going to hear this view from all of them. No one is saying that this accumulative, technology-driven productivity growth is showing any signs of slowing.4
In August 1999, four months before the 2000 stock market peak, FOMC member Alfred Broaddus also linearly extrapolated then-current economic conditions into the future. And then he, too, went for the laughs:
MR. BROADDUS. Mr. Chairman, … we see relatively few signs of any deceleration in activity in our region. … Car sales remain at an exceptionally high level. One of our bank directors recently told us that new car loans at his bank were at an all-time high. … As you may know, BMW has a big new plant in Greenville, South Carolina. … people down there like to say that in South Carolina BMW stands for Bubba Makes Wheels! [Laughter]5
The FOMC's laughter subsided after the social mood began trending negatively in 2000. Then it surged again as mood also pushed the markets — especially real estate — to new highs in wave b in the Dow (2002-2007). Approaching the peak of the housing bubble, the Fed was in an especially jovial and confident mood, unaware that a huge stock-market crash lay just ahead. In the January 2006 meeting, Fed President William Poole thanked Alan Greenspan for his "extraordinary influence" on Poole's life and then made a recommendation:
MR. POOLE. I have a suggestion for a title for your first book. … "The Joy of Central Banking." [Laughter] And I suggest that your second book be "More Joy of Central Banking." [Laughter]
CHAIRMAN GREENSPAN. "How to Be a Joyous Central Banker, Even Though We Don't Have Hearts." [Laughter] … Thanks very much, Bill.
Later in that same meeting, the Chairman and Vice Chairman engaged in mutual appreciation and over-the-top sappiness:
CHAIRMAN GREENSPAN. Vice Chair, [it's your turn to speak].
VICE CHAIRMAN GEITHNER. Mr. Chairman, in the interest of crispness, I've removed a substantial tribute from my remarks. [Laughter]
CHAIRMAN GREENSPAN. I am most appreciative. [Laughter]
VICE CHAIRMAN GEITHNER. I'd like the record to show that I think you're pretty terrific, too. [Laughter] And thinking in terms of probabilities, I think the risk that we decide in the future that you're even better than we think is higher than the alternative. [Laughter]6
Socionomics not only explains why the Fed was so jolly at these peak [laughter] times but also has great practical utility in using such observations in real time to predict a change of social trend. Contrary to the Fed's optimism in 1999, Prechter's The Wave Principle of Human Social Behavior went to press at that very time and showed explicitly in Figure 5-12 that the stock market was about to reverse course. Contrary to the Fed's record [laughter] in 2006, Hochberg and Kendall of EWI called for a major peak in real estate prices at that time.
An Elliott Wave in FOMC Laughter
We surmise that if social mood propelled the occurrences of FOMC laughter and if social mood moves in Elliott waves, then the laughter data should produce an Elliott wave. Indeed, smoothing the data by plotting a 12-month moving average reveals an Elliott pattern that counts complete in November 2007, about a year after the peak in Fed jocularity. Figure 5 shows the labeled graph with the Fed laughter data backset six months to reflect the center of the moving average. The top line is the Case-Shiller index for U.S. house prices, which peaked in July 2006 just three months prior to the October 2006 record high of 65 laughter notations. This is more strong evidence that social mood regulates the mood of the Federal Open Market Committee members.
Again, the Fed transcripts are released after a five-year delay; we sketched a [Laughter] notation forecast in Figure 4 based on what we already know about the social mood. The forecast says that as post-2007 data become available, we will see fewer [laughter] notations until the first half of 2009, and then more [laughter] after that—though not to 2006-2007 levels. The peak of the positive social mood extreme, along with "The Joy of Central Banking," has passed.
The Socionomics Institute studies social mood and its role in driving cultural, economic and political trends. The Institute's analysis is published in the monthly research review, The Socionomist. Learn more at http://www.socionomics.net/?reference=yh
1Transcripts and other historical materials. Federal Open Market Committee. Board of Governors of the Federal Reserve System. Retrieved from http://www.federalreserve.gov/monetarypolicy/fomc_historical.htm
2Akin, K. (2012, January 12). The correlation of laughter at FOMC meetings. The Daily Stag Hunt. Retrieved from http://www.dailystaghunt.com/markets/2012/1/12/the-correlation-of-laughter-at-fomc-meetings.html#entry14562168
3Meeting of the Federal Open Market Committee, February 5-6, 1991. Federal Reserve. Retrieved from http://www.federalreserve.gov/monetarypolicy/files/fomc19910206meeting.pdf
4Meeting of the Federal Open Market Committee, June 29-30, 1999. Federal Reserve. Retrieved from http://www.federalreserve.gov/monetarypolicy/files/FOMC19990630meeting.pdf
5Meeting of the Federal Open Market Committee, August 24, 1999. Federal Reserve. Retrieved from http://www.federalreserve.gov/monetarypolicy/files/FOMC19990824meeting.pdf
6Meeting of the Federal Open Market Committee, January 31, 2006. Federal Reserve. Retrieved from http://www.federalreserve.gov/monetarypolicy/files/FOMC20060131meeting.pdf
Alan Hall is a lead researcher for the Socionomics Institute. He began studying Elliott wave analysis and socionomics after meeting Bob Prechter in 1995 and came to write for Elliott Wave International in 2006. Hall has traveled widely, and has authored socionomic studies on Russia, European housing, war, stocks, commodities, commodity prices and environmentalism, epidemics, eugenics, secessionism and authoritarianism. He does a wide variety of research aimed at demonstrating the utility of socionomic theory. He received his degree in Fine Arts from Berry College, emerging into the 1970s bear market. He has enjoyed a wide variety of job experiences that span from outdoor therapeutic counselor to decades as a custom homebuilder/designer.