Current 'Hawkish' May Be Nothing More Than Future 'Dovish'

by: Alhambra Investment Partners

By Jeffrey P. Snider

The Fed is simply making it up as it goes, with nary a concern about being questioned on what is really disingenuousness. That starts with oil prices as there have been a number of Fed officials rushing to embrace them as some kind of "stimulus" that nobody outside a monetary magician (redundant) could perform. Orthodox economics despises "deflation" to its very core, having built the entire edifice of modern central banking on the idea that it is better to have 2% inflation than to "risk" something below should a depression suddenly spring forth.

All of a sudden, a massive collapse in oil prices is nothing to worry about. Perhaps if inflation was "well-behaved" prior to this point, that resplendent notion would hold minor validity. But the fact is that inflation in the US (as measured according to these very same people) has failed to meet that 2% target for now 31 consecutive months. Janet Yellen, for her part, pays no mind to any of this because it is "transitory." From her December 2014 press conference:

Inflation has continued to run below the Committee's 2 percent objective, and the recent sizable declines in oil prices will likely hold down overall inflation in the near term. But as the effects of these oil price declines and other transitory factors dissipate and as resource utilization continues to rise, the Committee expects inflation to move gradually back toward its objective. In making this forecast, the Committee is mindful of the recent declines in market-based measures of inflation compensation. At this point, the Committee views these movements as likely to prove transitory, and survey-based measures of longer-term inflation expectations have remained stable.

First of all, the word "transitory" does not apply to a situation more than two and a half years in the making. Unless we are speaking in geologic terms, her assertion here is as unsuitable as the idea of "a little" redistribution counting for "stability" is repugnant. That idea is betrayed even more by the manner in which she wholly and outright dismisses that credit markets are acting exactly opposite of every single premise the FOMC is proclaiming. Credit market indications of inflation expectations are not just falling, but falling quickly and significantly.

To which Janet Yellen replies, with a single word, "transitory." No mention of how or why credit markets would behave in a manner in which they have never behaved before, only that "the Committee views these movements as likely to prove transitory." Why?

That lack of justification for such an odd projection is made all the more so by what she said later on at that same press gathering:

Theory is important, and theories that are consistent with historical evidence will be something that governs the thinking of many people around the table.

The consistency of credit markets on this very matter underscores just how "transitory" would be the exact wrong word to use for this situation. What is historically consistent is that credit market bearishness alongside commodity collapse, not just crude, and "dollar" disruption is uniformly "bad." Furthermore, that "bad" typically lasts several years and is accompanied by all the economic deformations that Yellen says are impossible at this moment in time. Theories consistent with this kind of historical evidence have been thrown out the window by the FOMC.

All that matters in this public discourse is that Yellen believes in slack, a factor to which she somehow attaches historical validity. As she says in the first part of the first quote above, "transitory" is believed valid as resource utilization rises; leading to "firming" in economic pricing. That is a curious aspect upon which to hang the entire balance of monetary policy, as oil prices are set by "resource utilization" almost exclusively in these circumstances. We have long since past the point at which financial factors may be weighing on crude, and even beyond where supply growth is even relevant. At $47 a barrel now (and even Brent threatening below $50), it is clear that this primary resource is not being utilized.

Of course, in Yellen's situationally-deformed reasoning here, the only resource that matters is labor (and she is right, for all the wrong reasons particularly as her mission is to make sure wages grow as slowly as possible). But it is curious that she would lend all her credibility to higher rates of assumed and future resource utilization as a means to logically counter much lower rates of actual and present resource utilization.

In other words, I think these are pretty thin rationalizations. She is saying to ignore consistent market indication because she thinks the economy is getting better - she can see what nobody (but stock investors who follow her every word anyway) else does. There is distrust of markets and then there is simple convenience.

The more preposterousness these assertions attain, the more I am reminded that I never really believed that they ended QE because of the economy in the first place. Getting out of the bond buying business and threatening to end ZIRP gives the Fed "room" in the same respect that the ECB does not have it. Under rational expectations theory, what counts in monetary policy, as the FOMC practices it, is not the policy but the policy "surprise." To get more monetary "bang for the buck" is to suddenly and sharply shift out of expectations.

The Fed knows what credit markets are saying and is most certainly beyond concerned internally - which they also cannot admit, leaving them instead to practice childish circularity. By threatening ZIRP now while economic growth is ambiguous still, they have added a few interim moves to their arsenal. They can at the first instinct for "dovishness" push out rate increases by six months, cheering markets they hope, then a year, cheering them some more, then scrap them altogether and threaten to return to QE (and maybe not just in a government bond capacity, as my colleague Joe Calhoun warns; legal complications aside for now).

The important part of the effort these past months is to establish that operating margin for future problems, as clearly there are innumerable and immense future problems threatening right now. The rationalizations about "transitory" inflation, particularly in the context of 31 consecutive monthly target misses, sound silly because they are nothing more than misdirection for that purpose.

Of course, the question of efficacy is highly debatable now in a way it never was before, with additional scrutiny and doubt sowed by the European usage of monetarism and the Japanese versions. And if any recession develops here, there will certainly be some negative factors associated with QE3 and QE4, but the Fed has nothing left. Nothing. And that is the whole point, I believe, behind this silly dance about "transitory." Better, in their view, to pretend "hawkishness" as the economy slows significantly to at least gain some "surprise" options than to be left at full "dovishness" while it all falls apart.