Never has so much money been riding on ONE WORD from a monetary authority. The issue isn’t the idea of FED PATIENCE in regards to raising rates for if the FED increases the effective rate to 37 basis points from 12 basis points IT IS MEANINGLESS. The issue for the FED is the huge pile of bank reserves sitting at the central bank to the tune of $2.7 TRILLION (and let’s not forget the FED‘s $4.5 TRILLION balance sheet). If the economy begins to heat up and banks begin to circulate those RESERVES, the FED will have a velocity of money problem as the ECONOMY MAY BE AT SOME LEVEL OF FULL EMPLOYMENT. It’s not an interest rate problem for the FED but a RESERVE PROBLEM.
The market was abuzz with a story from Bridgewater’s RAY DALIO, a man I hold in very high esteem and not because of his wealth but his intelligence in the realm of global macro finance. Mr. Dalio compares the present FED dilemma to the FOMC decision of 1937 when the central bank acted to raise reserve requirements and interest rates in an effort to forestall a POSSIBLE rise in inflation. Dalio believes the FED should be reticent and make certain the economy can withstand an increase in rates. Janet Yellen believes the same, which is why the FED will be data dependent rather than patient.
I think Dalio’s piece is flawed because he fails to mention that the U.S. Treasury under Henry Morgenthau was raising taxes at the same time as the Fed was tightening in an effort to balance the budget and curb deficit spending. As Richard Koo and other’s have argued, the Fed erred by not holding off rate increase until the effects of fiscal austerity were fully understood. Yellen can use the excuse of current fiscal policy as an effort to remain cautious for the Federal budget is certainly a major data point.
There has been an “underground” battle at the Fed between Chair Yellen and Vice Chair Fischer over the use of “FORWARD GUIDANCE” in setting FED policy. For the past three years Fischer has been voicing his skepticism about the use of forward guidance as he believes it binds the FED even when conditions change. Bind yourself to a time-set policy and it’s a recipe for falling behind the proverbial curve. If PATIENCE is removed wait for Chair Yellen’s press conference in which she will walk back the immediacy of rate hikes and will comment of the recent tepid economic data.
Yellen’s primary caution will be a signal about her rising concerns about INTERNATIONAL DEVELOPMENTS (code word for the U.S. DOLLAR) since the DOLLAR is the purview of the TREASURY. Complicating things for Yellen was the stupid comments today from that global ambulance chaser IMF DIRECTOR CHRISTINE LAGARDE that a FED rise in rates will be problematic for the emerging nations that have large DOLLAR liabilities. This is not a new issue for my readers as I directed you to the important BIS Paper by McCauley, McGuire and Sushko, titled, Global Dollar Credit: Links to US Monetary Policy and Leverage, which measures the amount of emerging market corporations and the debt they have in dollars. As the dollar rises against their domestic currencies the weight of the liabilities for those corporations increases.
It was WRONG for Ms. Lagarde to voice concerns during a FED FOMC meeting for it appears as if she is trying to influence U.S. domestic policies. If Yellen doesn’t remove the PATIENT guidance it appears as if the U.S. monetary authority is bowing to international pressure, which would call into question the DUAL MANDATE. Tomorrow’s trade is going to be extremely volatile because the market will react to the FOMC statement, though whatever movement takes place can easily be walked back by Yellen’s Press Conference. I URGE PATIENCE.
***The yield curves continued flattening today as the 2/10 has fallen to a 10-day low of 137 basis points from 152 basis points post-nonfarm payrolls as traders believe the impact of the removal of PATIENT and a possible JUNE hike in the FED FUNDS rate will flatten the curve, especially as inflation seems to be under control and recent economic data tepid at best. If YELLEN walks back any sense of a near-term tightening, the CURVE OUGHT TO STEEPEN after the recent FLATTENING. However, the movements will be sudden, violent and subject to the parsing of words.
If Yellen walks back an imminent tightening, the DOLLAR will also come under pressure as many recent longs will be bothered by Fed reticence to raise rates. Coupled with the BOND, DOLLAR volatility will be the precious metals. Today, GOLD sold off until strong support levels and in a 10-minute sequence went to $1158.00 from $1141.6 on the buying of 4,000-plus futures contracts. Gold sold off for the next three hours but the quick bounce on no news was a tell of the looming volatility the market faces with tomorrow’s FOMC release and Yellen press conference. Yes, I must say it. Get your technical support and resistance levels up and speed and be PATIENT.