Fed Yellen Is Trapped in the Worst Nightmare Ever. Mauldin & Armstrong, Plus Video.
John Mauldin of Mauldin Economics
My thoughts on what I think is the very disturbing aftermath of this week’s Federal Reserve meeting.
It wasn’t a shock that the Federal Reserve did not raise rates. Even the most inside of insiders said the odds were at most 50-50. Those Wall Street Journal reporters who have an “inside ear” at the Federal Reserve all indicated there would be no rate increase. The IMF and the World Bank were pounding the table, declaring that it was inappropriate to raise rates now, and although most FOMC members give lip service to the fact that Federal Reserve policy is to be based solely on domestic considerations, global concerns may well have played a role in their decision.
What surprised me was the aggressively dovish stance taken by Yellen in her press conference and in the press release. It would have been one thing to come out and say, “We’re not going to raise rates at this meeting, but conditions are getting better, so get ready,” so that the market could have a little certainty. The statement we got instead, combined with early data from the quarter, is making me rethink my entire view on the timing of an interest rate increase.
My immediate reaction upon reading the press release was almost perfectly echoed by my good friend Peter Boockvar of the Lindsey Group):
The Fed punts AGAIN on a new set of excuses, and I'm so sorry to many....
The Fed punted AGAIN and thus are inviting us to the daily obsession of when they eventually will hike for another 6 weeks. While the economic commentary on the US was not much different than the last statement, they added “recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.” They see the risks to the outlook for economic activity and the labor market as nearly balanced but [are] “monitoring developments abroad.” Jeff Lacker is the only one that stood out from the crowd with a dissent and the desire to raise 25 bps.
Bottom line, the problem now is not when the Fed will raise rates or not, it is the paralyzing discussion about when they will eventually raise rates. We get to do this all over again as the Committee continues to day trade every data point not only in the US but now globally. They are the center of uncertainty and the multitude of excuses over the past few years has reached a tipping point that I don’t believe the stock market will continue to embrace. China has been slowing for 5 years and commodity prices have been falling for 4 years, and the Fed has now discovered them as risks to their outlook. Are we going to now price in the greater chance of a rate hike if China’s PMIs start to improve, if retail sales tail higher?
The Fed is implicitly acknowledging again that their policy action over the past 5 years of putting the US economy on a sustainable growth path has been a failure and now if their international concerns become more pronounced, they will also admit to the world that they have no tools to deal with it. I think today’s decision was a bad one. The dollar rally should be over and I’m bullish on precious metals (again) as I don’t understand at all what the bear case is in it anymore. Other commodities should benefit too from the weak dollar.… Therefore be cautious, the Fed did more damage to its credibility today.
Lastly and sorry to speak from my soap box to those who don’t care to hear it but, I’m sorry to the retirees that have saved their whole lives. I’m sorry to the generation of young people that don’t know what the benefits of saving [are]. I’m sorry to the free markets that best allocate capital. I’m sorry to pension funds that can’t grow assets to match their liabilities. I’m sorry to the successful companies that are competing against those that are only still alive because of cheap credit. I’m sorry to the US banking system, [which] has been hoping for higher interest rates for years. I’m sorry to those industries that have seen a pile of capital (aka, energy sector) enter their industry and have been or will see the consequences of too much capacity. I’m sorry to investors who continue to be bullied into making decisions they wouldn’t have made otherwise. I’m sorry for the bubbles that continue to be blown. Again, I’m sorry to those who don’t want to hear this.
What he said.
Granted, the global economy is slowing down. But Stan Fischer (Fed vice-chairman) gave an extremely strong speech not all that long ago, saying that the US Federal Reserve was focused only on domestic concerns. We just printed what might be the highest GDP number for the second quarter that we are likely to get for some time. Nobody is happy with the way the unemployment number is working out, but 5.1% and falling isn’t shabby. This is a slow-growth recovery that probably typifies the New Normal, so to expect to find an economy hitting on all cylinders before you normalize rates is not realistic.
This Fed, massively dominated by academic Keynesians, has demonstrated that the conditions for normalizing rates are far more stringent than many of us had been led to believe from the speeches of the FOMC members themselves. This is a Federal Reserve with hundreds of staff economists who create numerous models to guide their actions. The fact that none of these models have been anywhere close to right for decades should give us pause. Indeed, in her press interview Yellen admitted that the models don’t appear to be working.
We have a Federal Reserve that doesn’t trust its models and is running US monetary policy on its understanding of a flawed academic theory.
We’ve discussed in this space why these models don’t work; it’s because they’re based on a theory of economic organization that is fundamentally flawed and doesn’t reflect the complexity of the billions of economic reactions by participants in the marketplace every day. The only way the Fed can build a model to describe such complexity is to assume away the real world – to impute market motives and relationships based on their imperfect, academic understanding of how the world works.
Where are we? It is likely that before the December meeting we are going to see third-quarter GDP come in markedly lower than second-quarter GDP. If we are now focused on the global economy, as the press release suggested, that is also likely to be weaker. Inflation, at least the way the Fed measures it, is unlikely to be an issue. In this environment, will they raise rates? I now find that doubtful unless we get some remarkably boffo data points – which would be a surprise.
Going into 2016, a presidential election year, unless the US and global economies surprise to the upside, do we think we will see rate increases? It is now quite possible, it seems to me, that the next significant move by the Federal Reserve will be to initiate QE4 when the economy once again weakens or dips into recession. Remember, there is always another recession. The business cycle has not been repealed by leaving rates at the zero bound! Yes, I know that the Fed’s own research shows that QE was ineffective, but that will be one of only two weapons they still have in their arsenal. The other is negative rates, and I doubt they will start out with negative rates unless we get more than a garden-variety recession.
As Peter noted above in his final paragraph, the Federal Reserve has changed the fundamental equations of how investors, savers, and businessmen interact with each other. The Fed is distorting the essentials of the market. It is one thing to acknowledge that rates are likely to remain lower because we are in a disinflationary/deflationary world and will be for some time; it is another thing altogether to leave rates at the zero bound. One can make the case for lower rates and QE at the beginning of the Great Recession, but we have now created an environment where market participants may need to assume that rates could be at the zero bound for much longer than any of us ever dreamed. The longer the Fed postpones normalization, the more difficult the return to normal markets is going to be.
Martin Armstrong was a little more eloquently blunt is his latest post....
Yellen has inherited a complete nightmare. Thursday’s decision to delay yet again the long-awaited lift-off from zero interest rates is illustrating that the world economy is totally screwed.
This will eventually light the fire under the economy helping to fuel the Sovereign Debt Crisis. There appears to be no hope for the Fed and they will be forced to raise rates only when they see asset inflation in equities. Then they will have no choice. This is the worst possible mess and the longer they have waited to normalize interest rates, the worst the total crisis is becoming for they will have zero control over the economy and once that is seen, holy Hell will break lose.
Enjoy the video interview below, with Mark Spitznagel
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