(Source: The Daily Shot)
Post-Brexit vote and post Mario Draghi's call for an "aligning" of central bank policies, the FOMC is swiftly falling into line with the global imperative of the day. The heightened use of the word "uncertainty", in the last FOMC minutes, signals the cause of the alignment. The "uncertainty" perceived by the FOMC has created the certainty of the use of this word; which in turn creates the certainty of groupthink amongst its members.
Dallas Fed President Robert Kaplan moved further into line, when he opined that whilst the Brexit impact is growth negative it will take some time to manifest itself. Kaplan is therefore happy to wait to see what this negative outcome will be. Because the impact is already framed as negative, this puts interest rate hikes on hold by default; and potentially implies an easier monetary policy stance in the future.
Kaplan's message was reiterated almost verbatim by Vice Chairman Stanley Fischer. Fischer said that more time is needed to evaluate the Brexit vote; and that the FOMC will have much more information by the time of the next meeting. Whilst this position in theory makes the next meeting a live decision, the topic of discussion is just as likely to be whether to ease in the future rather than whether to raise interest rates again. By default, the Fed can pause its tightening indefinitely and also now has the option to reverse it.
Having flip-flopped spectacularly already, St Louis Fed President James Bullard consolidated his last flip-flop, rather than reversing or embellishing it. For him, the Fed is limited to one rate hike this year, pending developments on the data front.
Fed Governor Daniel Tarullo classified the economy as "not running hot"; and opined that he does not see the case for a rate hike until he becomes "more convinced that the underlying rate of inflation is around 2 percent." Tarullo was even more candid about the obstacles to a rate hike; and listed them as the immediate aftermath of Fed bank stress tests and the Brexit vote. Since the US banks did well in the stress tests, whilst two big European names did not, one can infer that Tarullo now feels the headwinds from Europe blowing through the American economy.
The change in rhetoric from Cleveland Fed Hawk Loretta Mester, also indicative of the creeping groupthink aka consensus, was insightful and possibly apocryphal. Cognizant of the fact that she cannot stand alone against the "aligned" global tide of central bank groupthink; Mester gave the groupthinkers a glimpse of the endgame that may be their failure. She may also have noted the Dallas Fed's new guidelines on communication, which call for gravitas and consistency.
Mester bowed to the overall consensus that now i.e. the July FOMC meeting, is not the time to hike. She even did her bit for the increased usage of the "U-word" when she opined that: "I've been one of the more positive ones in terms of the outlook for the U.S. economy, and I continue to be positive about it. But I take on board that there is increased uncertainty". She then reframed her call to hike interest rates, as warning not to remain easy for too long.
By reframing her call to hike, as a warning that waiting too long to hike will lead to the loss of credibility and the inability to apply unconventional policy ever again, Mester held a mirror up to the current groupthinkers. To create a clearer reflected image, she also opined that a dangerous financial asset bubble and/or hyperinflation are potential outcomes that will undermine the groupthinkers' credibility. The loss of credibility will then translate into a loss of the ability to respond to the next crisis with unconventional monetary policy. This will be end of central bankers as we have known them since the Credit Crunch. The FOMC groupthink flip-flop was then confirmed by the minutes of the last FOMC meeting, in which the mediocre June Employment Situation report clearly triggered the reaction.
The Employment Situation Report itself continues to make liars rather than just flip-floppers out of the FOMC. Thus far however their lies appear to be the minor misdemeanor of telling untruths, which the FOMC speakers actually believe to be true, rather than deliberately constructing a false thesis about growth and inflation. Fortunately for the committee, the Brexit vote had intervened since the last employment report; so that their flip-flopping was not even more embarrassingly exposed by the strong data. The strong June rebound, contained some internal signals of weakness; which when combined with the framing of the Brexit vote and its negative consequences was enough to vindicate the current on-hold position of the FOMC. Adopting a compromise view, the consensus is now being framed to rule out July's FOMC meeting for a rate hike but to keep the window open for September.
If the American economic data is not materially impacted by the Brexit, yet the FOMC continues to hold off on hiking, a point will be reached at which the untruths become deliberate fabrications. At this point it may be concluded that the FOMC has subsumed its own domestic obligations to some wider obligations to the global economy. At this point the rise in financial assets, will be the bubble that Mester warns of. It should be noted that this phase will be forced onto the Fed in any case.
Even without a rate hike the US Dollar, positive interest rates and unspectacular economic growth are magnets for global capital. Capital will thus reallocate to America, which will have some stimulating impact on domestic economic growth, inflation and asset prices. If the Fed then hikes, the impact on the global economy will be seen as much more negative; so that the capital flight into America will accelerate. The Fed is thus faced with same dilemma, that raising interest rates will actually require even higher interest rates to address the resulting growth stimulus.
If the Fed does nothing however, negative interest rates globally and the hunt for yield will also attract capital into America. Even the "uncertainty" of a Trump Presidency sucks capital into the American economy, to avoid global trade wars, so the US Presidential election is a non-event in market terms. Such a combination of asymmetric outcomes guarantees capital flow and its beneficial impact on American asset prices. Momentum investors and the poor performance of investment managers to date will do the rest! Loretta Mester's prescience is therefore early but essentially correct in the long run.
After seven years or so of unconventional monetary policy, the global groupthinkers still want to apply more of the same. Undeterred by failure to date and fearful of populism, they have concluded that their monetary response has not been strong enough. The dangerous financial asset bubble of which Mester warns is about to experience an even greater inflation.
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