I must admit, I had been expecting the Fed to be a little more hawkish over the past couple of months. Given how tone deaf they seemed during previous tightening periods when the US dollar was screaming higher and oil plunging to levels that would have resulted in entire states going bankrupt, today’s climate of rocketing risk assets and rising inflation seemed like a no brainer to err on the hawkish side. And I am not alone in this analysis. Recently Peter Broockvar, the Chief Market Analyst for the Lindsey Group published a great list titled “Why March Must be on the Table.” Broockvar went through a variety of economic metrics to demonstrate how economic conditions have heated up over the past couple of months. (the note was from last week, so some of the data is a touch stale)
5 yr inflation breakeven: 12/14 was 1.83% vs 1.97% today
10 yr inflation breakeven: 12/14 was 1.97% vs 2.02% today
Headline CPI: November CPI (the one they saw at December meeting) 1.7% vs 2.4% expected tomorrow for January
Core CPI: November CPI 2.1% vs 2.1% expected tomorrow January
Headline PCE: November 1.4% vs 1.6% for December
Core PCE: November 1.7% vs 1.7% for December
NY Fed survey of inflation expectations: November 2.5% vs 3% in January
UoM one yr inflation expectations: November 2.4% vs 2.8% in February
CRB index: 12/14 192 vs 192 today
Journal of Commerce index: 12/14 104.5 vs 108.7 today
December/January monthly private sector job gains averaged 201k vs the previous 12 months average 176k
Jobless claims 4 week average: mid December 264k vs 244k last week
Average hourly earnings: November 2.7% y/o/y vs 2.5% in January
Atlanta Fed wage tracker: November 3.8% vs 3.5% in December
U6 unemployment rate: November 9.3% vs 9.4% in January
NFIB Net compensation: November 21% vs 30% in January
NFIB Net compensation future plans: November 15% vs 18% in January
Since 12/13 (day before FOMC) S&P 500 up 2.5% to record high and up 9% since election (No uncertainty here)
10 yr yield on 12/13 2.47% vs 2.44% today and vs 1.85% on day of election
2 yr yield on 12/13 1.17% vs 1.21% today and vs .85% on day of election
It is tough to argue with Broockvar’s logic. Risk assets are screaming higher, inflation is rising, and the US dollar is not accelerating uncontrollably. Over the past couple of years, if there ever was a case to be made for a rate hike, it’s now. Yet over the past month, every time a Fed official gets a chance to talk up rates, they falter. Sure, they make some conciliatory noises about “every meeting being live,” but that’s BS and the market knows it.
Have a look at Fed President Neel Kashkari’s comments from a couple of days ago (from CNBC):
Minneapolis Federal Reserve Bank President Neel Kashkari on Tuesday said the U.S. labor market has “more room to run,” suggesting he does not believe the central bank should raise rates quickly to head off inflation.
Kashkari said in an appearance broadcast on the bank’s website that it has been a “big surprise” that so many workers have returned to the workforce over the past year and a half, and he is “cautiously optimistic” that the pattern will continue.
“I think that process has more room to run,” he said.
The Fed has raised its short-term interest-rate target only twice since the Great Recession, and last month decided to keep rates unchanged so as to allow the labor market to strengthen further.
Kashkari, a voting member of the Fed’s policy-setting panel this year, declined to say when he thinks the Fed should next raise rates. His remarks, though, left little doubt that he is not among the policymakers who are chomping at the bit to do so.
Wages are rising, he said, but they have not reached alarming levels, and he hopes they will climb further. The Fed, he said, aims to allow the economy to grow as fast as it can as long as inflation stays low.
“We don’t want to be the ones holding that back,” he said.
Kashkari said he has not factored any new fiscal policies into his forecasts because it is not clear what tax or other reforms will be enacted under President Donald Trump.
“More room to run?” That’s not raise rates next month talk. In fact, you could argue that’s “let’s not even bother with June” talk.
Over the weekend I read Danielle DiMartino’s book Fed Up. The book is unusual in that it gives an insider’s view of the Federal Reserve, and it’s not flattering. The biggest surprise for me was the extent to which Federal Reserve officials are out of touch. I don’t expect them to follow every tick in the Blue Eurodollar pack, but I was shocked at how little they followed markets.
Yet this explains a lot. During the 2008 credit crisis, the Fed refused to acknowledge the true extent of the damage in the housing market until it bled through to their economic indicators. But all they had to do was dial the ABX Markit Subprime Index to understand the carnage.
And it also explains why at the end of 2015 when oil was plunging to $26 they didn’t understand the damage their hawkish rhetoric was having on the global economy.
It’s like the Federal Reserve is Wayne Gretzky’s poorly coordinated older brother. Instead of skating to where the puck is going, the Fed can’t even skate to where the puck is, and is instead busy skating to where it has been.
I can’t remember who said it, but the metaphor of the Fed conducting monetary policy looking through the rearview mirror is bang on. Which means, until the very end of the economic cycle, the Federal Reserve will always be behind the curve.
It is ironic because a year ago the Federal Reserve was desperately trying to drag the front end of the curve higher, but the market realized the economy was not strong enough. The Fed kept trying to talk up rates, but market participants understood the Fed did not have the gumption to push through rate hikes in the weak global economic environment. Embarrassingly the Federal Reserve had to settle for one hike when they were predicting four. And in the process, they lost a ton of credibility.
Contrast that to today. Scared of once again having to backtrack, the Federal Reserve refuses to keep the March meeting “live.”
Don’t believe me? Even though the WSJ interpreted yesterday’s Fed minutes as hawkish, the Fed funds futures market for April did not even budge due to Kashkari’s and all the other Fed talk.
The WSJ is correct in that the Federal Reserve’s comments of “fairly soon” should mean March, but the market knows the Fed, absent a huge outlier economic release, has written off March.
The Federal Reserve should be setting up the market for a March rate hike, but they aren’t. So be it. No sense complaining about what should be. Our job is to figure out what will be and position accordingly.
And do you know who has figured out that the Fed is behind the curve? Our favourite little yellow friend…
A Federal Reserve slow to raise rates is the greatest thing for gold. During January gold was rallying with the US dollar sell off, but over the past month, even as the US dollar has rallied, gold has continued to perform well.
Who knows if the Fed will once again flip flop and surprise markets. But right now, it is tough to argue the Fed is out in front of the curve like last year. And if they stay behind the curve, reluctantly following the market higher, then gold should continue to rally, even in the face of higher rates.
Thanks for reading,