The Transitory Fed Moves Back Toward Its Asset-Price-Targeting Single Mandate
- Fed Chairman Powell uses the word “transitory” in the wrong context.
- The only thing that the Fed is certain about is its own uncertainty.
- The Fed says that it is now in the inflation expectations targeting business rather than the inflation rate targeting business.
- The Fed’s sole mandate remains the capital market asset price level management business first and foremost.
- Adherence to the Congressional dual mandate is a “transitory” phase of the asset price level management single mandate.
(Source: AZ Quotes)
The Fed is playing a dangerous game of Russian roulette with President Trump. As it clings to its current policy stance, as an alleged signal of its independence, it is making some fundamental mistakes. It is also playing hard and fast with the data and the corresponding economic narrative. If and when it is caught out, Fed independence will be a historical footnote. Chairman Powell's use of the word "transitory" is apposite. Unfortunately, he has used it in the wrong context.
(Source: Gallup, caption by the Author)
The latest Gallup Poll shows that confidence in Chairman Powell's economic management remains the highest in the land of the free and home of the brave. President Trump is still within Tweetin' distance of the Chairman. The Republicans are gaining traction, whilst the Democrats remain encumbered by their recent Socialist leanings into the wind.
(Source: Sportskeeda, caption by the Author)
The Chairman also needs to address the fact that the President is maintaining the pressure and currently making an overtaking move. The Fed has already reached for the white flag of surrender, as noted in the last report. It may need to formalize its surrender under cover, by waving the blue flag; thereby allowing the President to overtake it, on his way to achieving the checkered flag of his promised 4% GDP target. Ostensibly, the Fed is already waving the blue flag, by changing its monetary policy emphasis from the inflation to its growth mandate.
(Source: Sportskeeda, caption by the Author)
The latest "blowout" GDP reading reflects a blowout in inventory building, in the run-up to global trade negotiations. The latest plummet in Core PCE suggests that the Fed has followed the previously rising inflation trend too slavishly. The last rate hike was, therefore, a mistake. Combining the growth and inflation data, on the Fed's console, the FOMC should at least be waving the yellow danger-ahead flag.
(Source: San Francisco Fed, caption by the Author)
This sudden appearance, of hazardous economic conditions, has in fact been anticipated by Mr Market (and his flat Yield Curve) for some time; and totally unanticipated and understated by the Fed. The San Francisco Fed's recently cited claim, that the Fed knows more than Mr Market, is effectively being disproved by the data. The Fed's current flag-waving guidance is all over the place, and therefore deserving of the strong criticism that it is getting.
(Source: FOMC, caption by the Author)
The Fed's alleged edge is also disproved by the recently released FOMC minutes of the March meeting. The minutes record three discrete opinion groups within the Fed.
One minority group could go either way on the direction of interest rates. Another group is still intending to hike interest rates. The third majority opinion, to sit back and do nothing, is motivated by fear of the recent softening of domestic and global inflation and growth data. There is no true consensus. There is, however, a large cluster of uncertainty.
The only edge that the Fed has, therefore, if it can truly be called a unique edge, is that it knows that it is uncertain. Such self-awareness is not, however, unique to the Fed. The Fed is thus a heterogeneous mixture of foxes and hedgehogs, in Archilochus's taxonomy. The foxes know many things and can thus go either way on interest rates in consequence. The one big thing that the hedgehogs know is that they are uncertain.
The Fed has been taking some heat, not least from the President, for its forecasts and actions predicated upon them. It has responded in the same insidious terms as its accusers. Fed speakers and staffers have responded by opining and proving just how accurate they are. It's all a little too subjective and thus lacking in the objective intellectual rigor, which the Fed claims that all its hires should have.
The only value, in observing the Fed's response, is to conclude that (A) it is rattled and (B) it is trying to fight in the same devious ways employed by its detractors. A central bank that cannot remain aloof, in the moral high ground of independence, is one that has taken its eye off the ball. Such distraction undermines its credibility and its ability to focus on the real job.
The Fed is currently fighting for its life and its independence. Unaccustomed to this situation and also with the handicap of a new unseasoned Chairman, it is making heavy going of it. Fighting on the terms of one's opponent is strategic loss. The Fed needs defenders who are objective. Unfortunately, the only objective defenders are the data and Mr Market; neither of whom is noted for his/her loyalty and/or subservience to the Fed.
The last report listed the latest Fed blunders, in a catalog dating back to the GFC. The latest blunders were highlighted by an unprompted admission of failure, by the New York Fed, whereby the Fed now needs to buy more US Treasuries just in order to pause.
(Source: Bloomberg, caption by the Author)
This sorry state of affairs has been politely highlighted by Goldman Sachs recently. Goldman simply notes that the Fed no longer has the information edge. This loss of its information edge has translated into a negative impact on risk assets, over the period in which the Fed has been shrinking its balance sheet.
(Source: Kansas City Fed, caption by the Author)
What Goldman is saying is that the Fed has in fact tightened financial conditions ergo monetary policy. This view conflates with an apologia, from the Kansas City Fed, also listed in the last report. This apology came with the view that there has been a "Temporary Tightening" of financial conditions. Goldman finds that this "Temporary Tightening" has been more pernicious and longer in duration. It also finds that the Fed is directly responsible for this lengthy "Temporary Tightening". Any reference that Chairman Powell makes to "transitory" economic conditions should be framed by Goldman's not transitory contextual reference.
(Source: St Louis Fed, caption by the Author)
If one then puts the Goldman frame of reference into the St Louis Fed's own frame of reference, the situation begins to look ominous. Earlier this month, the St Louis Fed empirically found that the lower the level of real interest rate signals, the greater the severity of the following recession. The Kansas City Fed's findings are the riddle, inside Goldman's mystery, wrapped inside the St Louis Fed's enigma. In other words, the Fed's overzealous tightening, during its alleged normalization, has contributed directly to the approaching economic slowdown. The process of un-wrapping this riddle leads to the conclusion that the Fed has indeed lost the plot.
(Original Photo: UPI , editing and caption by the Author)
Heads should roll, beginning with the Chairman's. The Fed's "V-Turn" since the last rate hike can now be seen in clear context. It may not be enough to save reputations, however. The last report suggested that Chairman Powell's failure to date and widening credibility gap, with both his team and the President, may militate for him to honorably resign before his term is not extended. Goldman's latest findings are just one more nail in his coffin. Chairman Powell's famed monetary policy framework review this year looks to be concluded before it has really started. It also risks degenerating into a list of causes for his removal.
(Source: New York Fed, caption by the Author)
The last report observed the New York Fed responding to President Trump's attacks by engaging in the black arts of propaganda and active measures. In particular, the Fed was keen to blame the faltering housing market squarely on the President's fiscal policy.
(Source: New York Fed, caption by the Author)
This line of counter-attack continues, with the latest insinuation that fiscal policy has made housing unaffordable.
The Fed's ignominious retreat, behind these carefully constructed disclaimers of responsibility, under attack from President Trump for wrecking his GDP strategy was noted in the last report. The Fed is finding this retreat easier and concession-making less embarrassing, in the field of macro-prudential regulation, rather than in the more prominent field of monetary policy. In doing so, the Fed is helping to inflate the risk-asset bubble that it was so keen to deflate, with disastrous consequences for itself, in the last rate hike.
The Fed will now allow a more Wall Street-friendly definition of what types of trade are prohibited under the Volcker Rule. Since interest rates and hence bank margins are low, the banks can now engage in more risky prop trading. As the Fed has signaled a pause, in the rate hiking and balance sheet cutting schedule, this prop-trading and thus asset prices will mushroom.
The FOMC remained steadfast in its commitment to hold the line on interest rates with its latest decision. Chairman Powell even had the chutzpah to claim that the latest inflation down-tick is "transitory". Evidently, he wishes it to appear that he knows more than the average economist. The items that he chose to illustrate, as the "transitory" drivers of the current weakness, have a very low weighting in the basket from which the inflation number is derived. His opinion is spurious, and his method is egregious.
(Source: Wall Street Journal, caption by the Author)
Unless he intends to move the goalposts and create a new inflation index, that serves his purpose, Powell's chances of looking smart remain transitory. This sleight of hand should not be ruled out, as the battle with President Trump gets dirtier and more unconventional. The Journal reports that the subject of alternative inflation measures has already been broached by the FOMC. Evidently, there are some who would like to subjectively redefine inflation to a number that better fits their bias towards not easing.
The signals from the Fed's balance sheet indicate that the embarrassment following this transitory phase is just around the corner.
(Source: Author, caption by the Author)
The last report noted the New York Fed's admission that the Fed has lost control of the balance sheet. The result is that the Fed has to start buying more Treasuries, just to maintain its current unchanged monetary policy stance. The implications of this loss of control were evident in the FOMC's latest decision to incrementally lower the interest on excess reserves (IOER).
The Fed Funds rate has been bouncing off the higher range level. This clearly indicates that monetary policy is tight and getting tighter. It strongly contradicts the Fed's guidance that it has paused the rate hike cycle. Rather than admit that interest rates are too high, thereby falling into President Trump's trap, the FOMC is now trying to tinker with interest rates. The lowering of the IOER is an attempt to force the Fed Funds rate, below the upper range level, without officially cutting interest rates.
It is also an attempt to postpone the increase in the size of the Fed's balance sheet. If the Fed were to start buying Treasuries again soon, it would be an admission that balance sheet run-off is actually a tightening of monetary policy. So far, the Fed has strongly denied any link between balance sheet run-off and tighter financial conditions. Such a link would then throw the Fed's last interest rate hike into a completely different perspective. It would also put the Fed's stewardship and intellectual capacity in a very harsh spotlight.
The Fed is headed for the epiphany that balance sheet run-off was a tightening and that the last interest rate hike was excessive. Such an epiphany would be an admission that it doesn't really know what it is doing. At such a point, the Chairman's position is untenable, as are the positions of those who have blindly followed and defended him. Suddenly, Herman Cain and Stephen Moore don't look so unqualified!
In the meantime, the Fed's good ship balance sheet run-off is still steaming along. It is due to arrive at safe harbor in September. It should hit the iceberg well before this ETA. The greatest sign of impending risk, in addition to contradicting the Fed's claim that it has the information edge is the continued sheer lack of consensus amongst monetary policymakers.
The views range from potential rate-cutters, like James Bullard and Charles Evans, to hikers like Mester; with all kinds of permutations in between. Evans has now fully reverted, from Hawk back to his disinflation angst-ridden Dovish self. Bullard is prepared to cut interest rates if inflation remains muted.
Mester has become the classic two-handed economist. She sees strong GDP, yet is happy to remain patient. In the face of potential failure, to sustain the inflation at target, she has also moved the goalposts. Rather than address the current dip in inflation, she now chooses to talk up the fact that inflation expectations remain elevated.
On the one hand, Mester is systematic, and on the other hand, she is subjective. Being systematic would maintain Fed independence, but it would come at the great expense of the loss of flexibility. Giving up flexibility would be a sure sign that the Fed has no edge.
Ironically, all Fed speakers claim to be data-dependent. The data, however, tells all of them different things. Can it be that these foxes all have information edges which in total cancel each others out? Being patient is the summation of the equal and opposite views. One man's patience is another man's lack of consensus.
Fed Vice Chair Clarida embraced the fuzzy warmth of patience after the latest Employment Situation report. Strong job growth and weak wage inflation equal his patience. He clearly hopes that this embrace will be contagious, thereby leading to consensus amongst his FOMC colleagues. Currently, they are still cognitively biased to one of the growth and disinflation signals in the report. A holistic view of both remains lacking.
There is also an innate cognitive bias, amongst FOMC members, towards being more Hawkish, as Mr Market discounts their patience in the form of vertiginous rises in risk asset prices. The FOMC consensus, therefore, risks becoming a Hawkish one, over time, by default of the market consequences of being patient. Thus, patience is in fact a precursor to being Hawkish.
In the past, this market-driven Hawkish outcome has often come just as the real economy starts to weaken. The FOMC thus tightens at exactly the wrong moment for the real economy. In hindsight, historical inverted yield curve analysis confirms this bad timing. Equivocal data like this latest Employment Situation report will, therefore, destroy the consensus, unless FOMC members change their way of thinking. Without a change in thinking, the FOMC will then be automatically driven towards Hawkish behavior by market price action. As always, the Fed's dual mandate then degenerates, into inflating and deflating asset bubbles, thereby getting even further away from its Congressionally defined job.
Why even bother with the distraction of considering inflation targeting and/or holding a review of the Fed's monetary policy framework this year, if all the Fed actually does is manage asset prices?
(Source: New York Fed, caption by the Author)
New York Fed Chairman John Williams has gone some way to answering this question. In a discussion paper, he makes the case for inflation target overshooting. This overshooting should also be augmented, by a commitment to maintaining interest rates lower for longer. Inflation expectations would then be anchored higher in his view. It all sounds so simple that one wonders why nobody has suggested seriously in the past.
Williams seems as blind as Loretta Mester, to the fact that elevated future inflation expectations now converge backwards to lower spot inflation prices rather than vice versa. He also signals very candidly that the Fed is out of the boosting inflation with monetary policy business. The Fed is now strictly speaking in the inflation expectations business, rather than the inflation target business.
(Source: Exter's Pyramid, Quote by Milton Friedman, in parentheses by the Author)
At the end of the day, however, the Fed is really in the asset price targeting business, since this is the only economic indicator that it can directly influence with monetary policy. Fed Governor John Exter already told us this a long time ago, so take everything else that the Fed says with a huge pinch of salt.
In addition, the Fed is also targeting asset price inflation with macro-prudential regulation, by rolling back the Volcker Rule. If Chairman Powell appeared less willing to consider a rate cut, at the latest FOMC meeting, it must surely have been because he understands the macro-prudential tailwind blowing asset prices. Any hint that falling inflation is not "transitory" would just provide an additional monetary policy tailwind to the asset price inflation in progress.
This article was written by
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