It is a fait accompli that today’s Fed meeting will raise
rates a quarter point. The more important question is “How many more increases
are we likely to see in the New Year?” In order to determine that, we need to
know a few things: Why the Fed is raising rates, what their goal is, and what
data they are watching.
If we take the Fed’s own comments at face value, we can
eliminate “popping a Real Estate bubble” as the goal. Fed Chair Greenspan has
that it is all but impossible to identify a bubble in real time, and besides,
it is easier to clean one up afterwards than to prevent one. While each of
these premises may be (arguably) false, that is what the Fed is on record as
saying. Therefore, believing their words, we must accept that targeting the
frothy Real Estate Market is not the Fed’s primary goal.
Eliminating the bubble rationale leaves 2 key issues: Price
Stability, and Wages & Employment. As its been long apparent to everyone ‘cept most Wall Street economists,
Inflation has been robust, due to commodity demand. That’s reflected in the
actual price data of nearly everything (except income). Fools be warned: we
reiterate our belief that the “Core Rate” is the greatest sucker play in all of
That leaves Wage Pressure and Employment as the other key
issue. And as noted, Wage pressure is nonexistent. Real income has been negative
for most of the year. That’s not the reason the Fed is tightening monetary
Nor is job creation a basis for reducing accommodation.
Despite rumors to the contrary, this has been an extremely poor job creation
cycle, post-recession. There’s much less to the 4.4 million new jobs touted by
Treasury Sec’y Snow than meets the eye. That’s a peak to trough number;
measured from either the end of the recession or the start of the President’s
1st term, we get a 1.8 million number. Even the 4.4m number contains about 37%
projected birth/death adjustments – an unusually high amount of the total. And
we have seen an unusually large number of jobs created by Uncle Sam, rather
than the private sector. Beyond the mere numbers, we see the quality of jobs
created is much worse than the jobs previously lost, paying lower wages and
While the Employment data is generally discouraging, the
good news is the abysmal job growth leaves the Fed with options. There is
utterly nothing in the income or employment data forcing the Fed to keep
tightening. It remains a story of inflation, and nothing else.
We have never felt it is the responsibility of Wall Street
Economists or Strategists to “advise” the Fed as to what to do; instead, we
feel it is more advantageous to analyze their actions and what they may be
basing them upon.
The FOMC must “invest” in rate hikes the same way you should invest in stocks. You should not buy a stock because it made money last year but because you believe it will make money next year. The FOMC is looking at where we are in the business cycle and where we will be next year without rate increases.
The economy is not overheated. There are a few areas where capacity utilization is too high but these are few and far between; not much outside of energy, speculation is driving the price of Gold.
However, the backlog of durable goods orders is growing. Billion dollar projects are getting underway all around the world. The US economy is set to enter a boom phase. It is appropriate for the FOMC to get to neutral but the FOMC is currently like a rodeo cowboy with his rope and horse chasing a steer. Neutral is that point of intersection where the cowboy ropes the steer.
Not even the FOMC knows where neutral is; partly because the FOMC is only one of several hundred cowboys chasing the same steer. In recent weeks, rate increases have been posted by Central Banks from Canada to New Zealand. Mexico is perhaps the only country to lower rates in recent months. Even the sluggish Euroland has seen one rate increase.
The obsession with the FOMC is remarkable. The FOMC has a job to do. The evidence is that monetary skills have gradually improved for centuries. We do not have the panics or depressions today as we had in day’s gone bye.
John Law showed the world how to deflate a currency around 1750. All in all, Greenspan and company have done a great job. The business cycle is now an 8 or 9 year cycle. The mid cycle dips are no big deal. Some might prefer the more violent half point moves of prior years but the gradual .25% moves are just what our economy needs.
I know you’re probably thinking they’re over reaching by raising interest rates. But isn’t that the only way to stop inflation (ie Volcker).
I generally agree with your assessment of things. I’m also in Japan (thru some funds in my retirement, not EWJ), Latin America and have made some commodity plays
these last few years.
But I don’t fault them for lifting interest rates. We need to invert the curve, slow down the economy and let the malinvestment work its way out of the economy.
Do you guys at the MAXIM group ever look at reverse index funds? Or do you just have a bunch of traders doing the shorts for you in bear markets.
Great post Barry.
The fact that the Fed and Fed watchers are declaring that it is not housing that is worrying them but something quite separate and different and entirely disconnected, is getting to me. (As if those ARMs buyers in 2003? might sue Greenspan for bad advice.)
Yes that devil inflation has crept in the door somehow despite the Fed’s vigilance of taking the door off the hinges for a couple of years in the interests of a shallow recession. (The marvels of the maestro: no pain, now or later.)
I know one of the catch phrases is ‘transparency’ (and the Fed is twice as transparent now that the minutes are released a couple of weeks after the announcement , yes?) and it is an indescribable joy to look for those word changes from one meeting to the next. Ok, maybe only for some.
This is transparently clear to me: the official CPI or PCE stat is not the only data the Fed is watching. Any sag in consumer expenditures will be supported by those cashouts the Kennedy Greenspan paper identified. Should housing recede to the point that consumers cannot tap this source of equity, the Fed will pause. As those buckets of cashouts empty, the Fed will be retracing.
I agree with most of what you think about inflation. Where I think you deviate a little from the “core group” of thought is in your analysis of how it should effect Fed policy. Fed policy should care more about core inflation than headline as long as food and energy are inelastic commodities and therefore are much less likely (although not impossible) to change inflation expectations. It is the expectation of inflation that creates hoarding and sped up buying that creates consumer inflation. In my view, the Fed rightly worries about inflation that is created BY the consumer (demand) rather than by fluctuations in supply of commodities.
There is no doubt that most things cost more and that is probably the reason the Fed will likely go to at least 4.5%, which would be considered a fairly restrictive real rate using the core number of 2.0 or lower. It’s the inflation mania they want to avoid.
I honestly think the Fed wants headline inflation because it is my view that world is still in a deflationary trend. How can there be inflation expectations when we won’t buy cars, clothes, etc. without incredible discounts or incentives. That is a deflationary mindset that won’t go away until wages have caught up and surpassed inflation for an extended period of time (not likely to happen with globalization in it’s mid-life stages at best).
Good Not Great Holiday Shopping Season
Back on December 1, I mentioned that Holiday sales increases can be in the 3 to 4% range. This modestly Bullish call was at the very low end of Wall Street projections. The prime motivation for that range was the decreasing gasoline prices post Katrin…