Here we go again. The bozos at the Fed obviously learned nothing from their disastrous December tightening. Even though it was the first tightening in a decade, and especially unpredictable due to the large amount of unorthodox programs executed during the previous eight years, the FOMC tightened and then continued to talk up further rate hikes. Remember the bloody dots? A smarter move might have been to tighten, step back and see how markets and the economy reacted. Instead the Fed barreled ahead guns blazing until the vicious feedback loop from a higher US dollar and lower commodity prices threatened to bring the global economy to a screeching halt. Yellen had to come in and save the day with a speech in which for the first time in history, the Chair of the Federal Reserve admitted to tuning monetary policy for non-US conditions.
Since then, the markets have assumed the Fed would be on hold for the near future. Yet there is a group of hawks at the Fed who seem to want the market to be kept off balance. This group appears determined to once again talk rate expectations back up. Even though the US economy has been consistently under performing expectations, these fools are determined to once again undermine the budding recovery.
I get it, they are worried about inflation. They should be. But the days of old school growth coming out of an easy monetary period are gone. The balance sheet constrained world economy means Central Banks must be slow to hike, with the Federal Reserve especially so.
Yet these hawks at the Fed don’t get it. Instead of realizing the market might be sending them a signal, they choose to fight the market.
Yesterday the question of where they stand was put to rest. There can be no denying this group is trying to alter market rate hike expectations.
First there was Lockhart. From an interview in the FT:
Financial markets are being overly pessimistic about the US outlook and may underestimate the chances of an interest-rate increase as soon as June, according to a senior Federal Reserve official.
Dennis Lockhart, the president of the Atlanta Fed, said recent inflation readings had been “encouraging” while early signs pointed to growth rebounding from a soft first quarter, meaning that June should be a possibility for a move.
Then Williams followed up with comments suggesting inflation was higher than the economic releases suggested:
WILLIAMS: WAGES PICKING UP BY MORE THAN SUGGESTED BY AVERAGES
Not to be outdone, Dallas Fed President followed up with:
“Whether that’s June or July, I can’t say right now,” Kaplan told reporters after a speech. He said would prefer to pause after that first 2016 rate hike to assess conditions, and while he would “hope” to continue to normalize rates thereafter, the pace of rate hikes will depend on incoming economic data.
But then the real kicker that cemented the Feds’ hawks plan to talk short rates back up was WSJ’s Jon Hilsenrath’s article in WSJ Pro. This edition of the WSJ costs $2,500 a year and is designed for plugged in money managers.
Finally, if that wasn’t enough, rumours of a think tank report circulated through the market. From the great Dave Lutz of Jones Trading’s daily trading colour:
“Hearing a think tank report is out there concerning the Fed and a messaging offensive to brace the market for a June move. Makes a certain amount of sense. Heard there is a piece out by Hilsenrath also talking about the disconnect between what Fed officials are saying and what market expects. Seems the market is being warned.” (IFR)
“NY Think Tank..suggesting the FEDs messaging offensive is underway, culminating with Yellen’s speaking engagement scheduled for 5/27 and 6/6 which is intended to move the markets pricing for a June hike. “ (MNI, but they emphasize “do NOT know source here. handle with care”
That’s all it took. With visions of January in their heads, investors hit the sell button. And I don’t blame them.
If the Federal Reserve is once again trying to raise rates before the market is ready, then the same outcome of a US dollar rally combined with a painful commodity and stock sell off will occur.
I am not sure what is going on at the Fed. These contradictory signals only make the job of managing the economy all the more difficult. But if the camp at the Federal Reserve operating with an old playbook gains control, then we have lots of problems ahead. The economy cannot handle higher rates. The yield curve has already flattened to the point where it is screaming caution. Instead of listening to the market, the Federal Reserve seems intent on telling it where to go. This would be fine if they were steadfast in their conviction and would be willing to sit through a cleansing severe recession where a bunch of credit destruction would allow the economy to reset. But you know the moment things get squirrelly, the Fed would be right back with their easy policies.
It’s dumb. They keep fighting with one hand tied behind their back. Choose one path. Either allow the economy to enter the natural credit destroying cycle and sit through the pain, or get it over with and inflate the problem away. It’s this flip flopping back and forth that is the real problem. All that does is make the eventual reset all the more painful.
What to do
Those last few paragraphs are sounding precariously close to complaining about what should be done instead of what will be done. In the spirit of just accepting what is, I am taking some steps to protect my portfolio if these hawkish Fed members keep getting their way.
At the present time I am not sure which camp will win out. Are these hawks just making some squawking sounds? Will the doves prevail and allow rates to sit at low levels until the market signals it is ready?
I don’t know. But I know that over the next few weeks, the risks are more skewed towards the hawkish story gaining traction. Regardless of outcome, the market will continue to price in more risk.
I bought some US dollars yesterday. We have had a little more than a year of sideways action in the USD, and last week, support once again held. It wouldn’t take much for me to imagine the DXY rallying back up to 100.
I think buying US dollars to express the view of an overly aggressive Fed is a much better trade than shorting equities. During all 2015 speculators were net long whopping amounts of US dollars. This spring they got shaken off, and they have now flipped to a small net short.
A scramble to put this long US dollar position back on would easily lift DXY to 100.
Thanks for reading,