a lame duck FOMC? ?3

02:51 20-Sep-17


A subscriber writes:

Hi Esekla,  Curious on your thoughts regarding tomorrows Fed meeting/Yellen presser? Seems almost impossible to conceive given market environment, but I’m wondering what the chances are the takeaway is hawkish. They have mentioned elevated equity prices, unemployment is ultra low, growth is moderate, slight tick up inflation, etc. How long can they just postpone making a move regarding balance sheet at a minimum and wouldn’t they be concerned about creating an even bigger bubble in markets?

That said, will it be just more of the same, i.e. data dependent, wait and see, etc.?

I have to start by saying that I don't know what the FOMC will say or do tomorrow.  What's more, I'm pretty sure that I won't care what they say, as implied by my last macro note, a week ago.  Most people seem to think the Fed will talk tough (hawkishly), thereby setting up expectations for a rate hike in December.  More important than interest rates, though, is what the Fed does with its balance sheet.  The signals have been that reduction would start soon, quite possibly with this meeting.  I'll try to provide some of the thinking on both sides of that argument and go a little further.

How Soon is Now?

Mainstream thinking is that the Fed needs to normalize both interest rates and its balance sheet in order to rebuild some fire power for dealing with new problems that may arise down the road.  It wants to do that very slowly, in order to avoid upsetting the economy, and by extension, the market.  So, now we've seen the funds rate bumped slowly up to 1.25% without really riling the markets.  Time to get to work on that balance sheet, right?

There is even more caution surrounding balance sheet reduction, because the QE that swelled it in the first place is relatively uncharted territory that has caused all sorts of economic distortions.  Federal Reserve Governor Lael Brainard basically admitted as much by spending the majority of the most recent speech pondering why inflation has remained persistently below target, despite better employment and other figures.  Still, if you've got to do it sooner or later, why not start trying now?

A Peek Behind the Curtain

There is actually a good reason why not, but to comprehend it you need to understand the theater of modern monetary policy.  What you won't hear from any FOMC member, or most mainstream media is that inflation remains low because it, and other numbers, are fudged, or at least so modified that they no longer have much relevance to most Americans.  The labor participation rate remains around 63%, meaning that almost 4 out 10 people that could work do not.  Core inflation excludes food and energy, but bifurcation of incomes means that most are concerned with little else and the rest have more capital than they can use for anything other than chasing return.  On the global level, this shows up as the  U.S. needing to inflate away its foreign debt, no matter how much it hurts the working class.  Nobody in power wants to state this narrative plainly, but it's probably the biggest reason why we might see not much action, and a return to weakening the dollar.

Underlying that is the fiction that the FOMC has independence from politics.  There is a very slim chance that fiction could start to change, but whether it does or not a cynical mind could be forgiven for thinking that the changes are all about who benefits from regulation and monetary policy.  Those who think tin-foil hats are stylish might go so far as to wonder if real decisions could be waiting on the Mueller investigation.  If so, we could have a while longer to wait.  Consequently, I won't care what the FOMC says tomorrow, only what they do.  If we do see the start of balance sheet reduction, some negative market reaction proportionate to the pace and any associated rise in USD would be reasonable.  If not, I expect it to continue along the choppy but positive trend I'd already projected, quite possibly through the end of the year.