Blame the Fed?

As you might have suspected, I disagree with
those who are blaiming today’s whackage on the Fed; In particular, Michael Moskow’s interview with CNBC’s Steve Liesman. 

Bob Marcin, whose views I always respect (tho don’t necessarily agree with) blames Moskow as to the causes of the selloff.

"In my opinion part of the market’s decline is due to the Michael Moskow CNBC
interview this morning. I think the Fed and Mr. Moskow just don’t get it.

They continue to press the rate hike story. It’s a mistake. The real estate
market is in disarray. Consumption is slowing. And much more slowdown is baked
in the cake.

And this glorious morn, we get to listen to Moskow pitch his "personal"
inflation target of 1-2%. Well, that’s absurd.

Just 2 years ago, Easy Al took rates to zero because the PCE was at 1%. How
can the deflationary depression scenario come out at 1% inflation, and an FOMC
member have the same rate in his normal target range? You can’t, period.

If 1% gets us a Fed panic, I humbly suggest taking the range to 2-3%, with
the midpoint being the real target. Then, the pause option becomes much more
viable now.

I am on the record calling 1% Feds fund a mistake. I want to be there for
this call. I think a second half material slowdown is a done deal. Give me a 6%
Fed funds this year and I promise you a recession next."

Then why the sell off?

There has been an ongoing technical decay in the markets for sometime now,
and that’s a reflection of all these seperate elements. The Fed is merely one
(amongst many) issues weighing on equities. I would place a heavier emphasis on
the emerging markets meltdown, the commodity correction, the dollar’s slippage,
WalMart’s numbers showing high energy prices biting consumers, GM’s downgrade,
and the general real estate/housing slowdown, on top of all the cyclical factors
we have mentioned.

But since the Fed is the topic at hand, recall how we got much of this
reflation/inflation: It was that very same 1% that lit the fire the Fed is now
trying to contain.

Consider the Hobson’s choice dilemma all Fed Chiefs must face: On the one hand, if
they overtighten, they will force the economy to slow too much, and risk a
recession. On the other hand, if inflation gets away from them, it can become a
runaway wildfire. They have a very hard time playing catch-up, given the
self-reinforcing tendency of inflation to feed on itself. So they end up forcing
an even more severe recession.

I think the US economy is resiliant and multi-faceted — and the Fed knows
this. Historically, we have shown the ability to bounce back from all kinds of
problems. The Fed knows this also.

This pair of choices is why, IMO, the Fed tends to overtighten. The always
rebounds from a recession, and relatively quickly, also. On the other hand,
1970s-style inflation haunts the dreams of all economists and especially those
who sit on the Fed. I suspect soft landings are mere serendipity, and not the
result of brilliant Fed policy.

Given this choice, it’s not too hard to see why the Fed is likely to
over-tighten. Of they are wrong, we get a mild recession, which we always bounce
back from. Let inflation get away from the Fed, and (shudder) it gets ugly.

Hence, they do what must be done to keep inflation well contained . . .

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  1. jj commented on May 30

    Not to completely downplay the blowoff today , and realizing it’s post-holiday trade , but volume was only 1.55B on nyse , and the DIA’s ,SPY’s , and QQQQ’s traded 70% of their recent 10-day volume …. a positive there ?

  2. bsteve commented on May 30

    I watched the interview with Moscow. He was perfectly rational, lucid, honest and ultimately neutral. He simply echoed the statement that the Fed is data dependent. There was nothing in his remarks that affected the futures at the time he was speaking which were already down. To blame him for the sell-off (Europe was already way down) is absurd and ultimately purile. Steve Liesman (sp?) should be fired. He is the very reason the phrase, ‘bring in the clowns’ was invented with his childish claims that inflation really isn’t so bad and his silly presentations of the Fab Five reasons the fed might pause. Give me a break! And watch the dollar flush itself down the toilet and then let’s see if the market ralleys. The Fed is in a corner of their own making but they are, so far, doing a decent job of backing themselves out of it.

  3. jcf commented on May 30

    Barry, is that a Hobson’s choice the Fed faces or merely a classic dilemma?

  4. Mr. Beach commented on May 30

    Now the market is waiting with baited breath for tomorrow’s release of the Fed May meeting Minutes.

    For you Barry, I’m gonna look into my crystal ball and predict the content of the minutes. Here is my summary:

    1. The Fed is data dependent.
    2. The Fed wants to pause to let the lagging effect of monetary policy show up in the data.
    3. The Fed wants to keep inflation contained.

    In other words, we will find nothing new in the minutes.

    The real question that the market is grappling with is this: what is the time period between fed action and effects on inflation indicators??

    Since the Fed has been raising rates for a while now, why are inflation indicators just beginning to light up? Will the lagging effect of prior rate raises snuff out these inflation indicators in the next few months?

    Or does the Fed need to act again (and again) to stamp out the signs of inflation?

    I would be surprised if the Fed minutes answer these questions.

    What do you guys think: if the Fed pauses, how long will it pause for? What if the inflation data continues to shock to the upside? What is the real lag as evidenced by the data and what is the lag, as defined by the market soothing needs of the Fed?

  5. juan commented on May 30

    Right –

    Dollar management, so very likely higher funds rate in an attempt to prevent uncontrolled decline vs not bringing about a consumption collapse that would have tremendous [B]global[/B] consequences.

    Why do I imagine the Treasury/Fed imagines some type of Plaza Accord ‘salvation’ even though conditions are very different.

  6. pjfny commented on May 30

    bsteve…I agree that the fed is in a corner (of their own doing), but complacency, record imbalances and leverage (consumer and financial mkts, carry trades etc) does not lead to muddle through scenarios,imo, but breed panic and deep recessions. If we think the Fed has managed to figure out how to avoid deep recessions, we are fooling ourselves…recessions cannot be avoided with crude short term rate tools. They come from riskaversion trades and a change in the psychology of mkt participants. I don’t know if the recession is going to come from a dollar crisis because of the fed stopping too early or a consumer slowdown because of overtightening by the fed, but either one could happen because of the leverage/complacancy (under pricing of risk)/ the external deficits and a change in psychology as the central banks take back the enormous liquidity they have injected in the last couple of years.Then we will see, which one of the central banks with overextended dollar exposure, blinks first (not because they want to, but because they will be forced to by fear),

  7. me commented on May 30

    “The always rebounds from a recession, and relatively quickly, also. ”

    I am still waiting for the job market and wages to recover from the last recession. PS it is no longer

  8. clunk commented on May 30

    I think the market has finally recognized how inept the fed is and has been. They should not have went to 1% and the hikes should have been in 1/2% increments instead of all those ridiculous quarter points. Bernanke appears clueless.

  9. Dennis Chan commented on May 30

    There is really nothing that the Fed can do at this point to avoid a recession because the root cause of this bear market is the worldwide massive credit expansion of the last fifteen years. This massive credit expansion encouraged market players to take massive risks, massive factories overbuilt, massive runup in real estate prices. etc… These excesses cannot be corrected easily and fixing these problems will take years. Hence, this month we are just entering a worldwide secular bear market. Our markets have a head start when Nasdaq crashed in 2000.

  10. DJ commented on May 30

    “The always rebounds from a recession, and relatively quickly, also. ”

    I guess the 1930s are beyond anyone’s memory. As they say, generals always prepare for the last war. The last war being 1970s stagflation in this case.

  11. Mike McGinley commented on May 30

    Here’s a thought…do away with the Fed. Let the market set rates.

  12. mrmanny commented on May 30

    Excellent comments from everyone… clearly the global economy needs to cool off ( recession or prolonged no-growth softlanding ) to correct the massive liguidity bubble and the consequent market distortions that have built up the last 8yrs or so. Importantly, The fed may not fear this (rightly or wrongly) since their ace- in- the- hole Bernanke has long studied on how to prevent the dreaded deflationary depression. Of course the politicians will not want a significant slowdown until after the election … thus the pause .. that refreshes their election chances…

  13. todd commented on May 31

    you guys are too bearish. the markets and the dollar will probably go lower over time, but not overnight.

    The Dow is still in a six month up channel and the NAS is in a 2 year up channel. We’re testing the lower limits in both… but that doesn’t mean it’s over.

    Overseas markets have had big corrections just like this one, and they’ve been excellent buying opportunites. Even if this is “the end,” the markets will most likely text the highs before a true change in market direction can be established.

  14. adam commented on May 31

    As I said before, we are witness to an incipient liquidity crisis. Bernanke’s favorite research topic is the Great Depression (the Japanese deflationary implosion comes a close second). Let’s see: risk of global economic collapse vs. couple of extra tenths on inflation rate. Tough choice. Not!

  15. S commented on May 31

    This thing ends ugly. No way around it. Inflation is already outside the FED’s comfort zone, and will only get more so over the next couple of reports due to OER’s impact on CPI. So, how can a FED that has said its actions will be dictated by the data pause when the coincident data will clearly show rising inflation? Bernanke can’t jeopardize his credibility this early in his regime. The FED will not, in fact it can not, pause. The seeds for the ’07 recession are being sown.

  16. D. commented on May 31

    We know that the economy works at the margin. We know a 4% drop in unemployment works wonders and warms up things a little.

    A 4% drop in unemployment in the Western world is equal to 30 million new people entering the work force and spending their new earned money… and taking loans. (1,000,000,000 x 4% x 70%). Let’s put 30 milion in perspective…

    I’m willing to bet that in the next few years there will be much more than 30 million Indians and Chinese attaining middle class status. In fact, in coastal China, the population’s spending power is accelerating rapidly.
    They will want middle class amenities and this will create huge demand for commodities.

    This is it, the writing is on the wall. China has turned the corner and Greenspan accomodated it. A 1% Fed funds rate and promise that it wouldnt’ budge for a while gave the developing world much needed time to build up its infrastructure thanks to all time low credit spreads!

    Apart from commodities, some of these developing countries are now probably quite close to being self sufficient by now thanks to their huge investments in the last few years. Actually, they could use their hundreds of billions in US treasuries to buy a few mines here and there and sign new deals with the Middle East!

    The Chinese must be laughing all their way to the banks considering American banks are buying significant positions in them despite large numbers of non-performing loans. If they are forced to go through the wringer, so will America!

    If someone can convince me how China will not be creating huge demand for commodities in the near future, I would appreciate the insight because right now I just can’t see past that.

    And if everything goes smoothly, Chinese demand for commodities will get bigger for sure and keep on driving up inflation.

  17. jm34 commented on May 31

    the average Chinese makes $1500/year… can’t believe they’re laughing all the way to the bank… even when their ecomy passes ours in 2050 by total GDP , their GDP/population will still be 1/3 of ours…. who’s laughing now

  18. D. commented on Jun 1

    I don’t care about the average Chinese, I care about the 30 million or more who will have buying power and affect our input prices.

    I don’t care about the size of their GDP, I care about whether or not they could hurt us. And they could and they are.

    Like I said, the economy works at the margin. It’s not the level, it’s the pace of change that produces shocks.

    Keep on underestimating the Chinese, that’s your pejorative like millions of other Americans.

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