It’s time to take a few days and recharge the mind. But before saddling up and heading off into the SUNSET here’s a few concepts to consider. Longtime NOTES readers know that the tagline 2+2=5 is a very serious construct for thinking outside the proverbial box. The line comes from Dostoyevsky’s short story, “Notes From Underground” in which the Russian master of literature protests against the RATIONALISTS who pretend to be all-knowing, like the FED MODELS. Just because things appear to be in balance doesn’t mean they are factual, so my goal is to look beyond conventional wisdom and find relevance and profit opportunity in what may appear to be mundane. While I am away new readers to NOTES should look back in the archives to see how we dissected ordinary news to find investment possibilities. The aim is to achieve economic gain through the analysis of politics and economics for the combination of political economy is the main thrust of this BLOG. Now, tomorrow and the FED:
1. The market wants to believe that the YELLEN Fed desires to raise rates before the year is out and is set on September because that is the optimal calendar date. Waiting for December would be Grinch-like and the Fed does not want to prolong the market reaction. The recent housing data (see Santelli interview with Mark Hanson) seems to be a vote against the fed raising rates as does the consumer confidence number released today. However, the recent jobless claims number and signs of rising wages provide fodder for a FED HIKE. The Fed’s speeches have been mixed, with some calling for rate rises sooner rather than later and other notable doves lobbying for a delay in a rate hike.
In MY OPINION the dissonance within the Fed seems to reflect the battle between Yellen and Vice Chairman Stanley Fischer. It was the vice chairman who pushed for removal of the forward guidance language in the FOMC STATEMENT and has hinted at the need to raise rates from the zero bound so as to enable the SOMA to activate a genuine reverse repo/interest on excess reserve policy.
It would be a test of this hypothesis if the FED HELD rates steady through the September meeting and Stanley Fischer resigned as he would have lost the argument. This is conjecture but is what separates the world of NOTES from the predictions of conventional analysts. For as Keynes said: “Worldly wisdom teaches it is better for reputation to fail conventionally than to succeed unconventionally.”
2. Making the call on Yellen’s desired move is the Fed Chair’s favorite barometer, the Labor Market Conditions Index(LMCI), a compilation of 19 variables measuring the health of the job market. Many months ago I questioned the use of the LMCI because it provided the latitude to keep moving the goal posts. Remember when the FED suggested that the full employment goal was 7%,then 6.5% and on and on? Now we are at 5.4% and the Fed has kept policy constant.
Listen for Yellen to discuss the PTER part of the LMCI–part-time for economic reasons–meaning there is far more slack in the labor markets than the traditional index reveals because many people who would like full-time employment do not have enough hours, therefore more slack exists in the real economy. PTER may be the justification for Yellen prevailing over Fischer.
3. If the FED actually does raise the Fed funds rate the YIELD CURVE will become the most important barometer of market sentiment. Today, Richard Bernstein made the point on CNBC that if the Fed raises rates and the yield curve steepens it will signal the Fed is judged to be behind the proverbial curve and will need to be more aggressive in further tightening. But if the curve were to FLATTEN it would indicate the market believed the Fed was premature in raising rates. This has been the argument I have raised in NOTES for the last few years.
This will be especially so because the FED‘s program on new large-scale asset purchases has ended. Any hint in tomorrow’s FOMC statement about a September hike should also have a great impact upon the yield curve. Be patient and let the market do its reaction before becoming too aggressive. The DOLLAR will also get a bid if a September hike is deemed to be closer to reality. Be cautious as we’re in thin summer markets. The closes on Friday will be far more telling then the nano second reactions of the algo headline readers. If the yield curve STEEPENS because of the market sensing no Fed action the equity markets should remain BID. It is not long-end rates that drive the near-term direction of the stock market.
***In tomorrow’s Financial Times there is an article by Peter Spiegel titled, “Let Debtor Nations Exit Euro, Say German Experts” (h/t JB). The five wise men of the German Council of economic experts recommended that, “A permanently uncooperative member state should not be able to threaten the existence of the Euro.” The article says that Chancellor Merkel’s poll ratings rose the tougher her and Mr. Schaeuble reacted to the Greek demands for debt relief. The wise men further note, “To ensure the cohesion of monetary union, we have to recognize that voters in creditor countries are not prepared to finance debtor countries permanently.” Earlier in the week, Italy’s Finance Minister Pier Carlo Padoan suggested in another FT article that there OUGHT to be greater integration in the Eurozone. Particularly, “… completion of a banking union, the establishment of a common eurozone budget and the launch of a common unemployment scheme to reinforce the common currency.”
In direct rebuttal to the Italian, the five wise men rejected the proposals as an attempt to counter Berlin’s emphasis on austerity and tough fiscal rules for eurozone members. In a concluding statement for the push by large debtors for a fiscal union of expediency the German economists warn: “Making the euro area collectively responsible for potential costs without member states giving up any national sovereignty over fiscal and economic policies would, sooner or later, make the currency union more unstable.” This is a direct slap at the French who have wanted the German checkbook without sacrificing sovereignty over its fiscal policies. Europe may be on vacation but the continued fallout from the Greek crisis and Schaeuble’s GREXIT PLAN remains on the boil. If the FED believes the EURO crisis is resolved … Oh, wait, Janet moved the goal posts again.
If anything heats up while I am marinating ice cubes (Art Cashin), I will write a note as being away doesn’t mean removed. If you have any questions or suggestions send them to email@example.com. Enjoy some downtime one and all.