Notes From Underground: The Fed Moves From Wall Street to Madison Avenue

Last week New York Fed President Bill Dudley opined that the economy looks great but is less compelling in regards to raising interest rates, while the Fed’s Vice Chairman insisted that we only want to do things right. There were also other Fed Presidents offering their thoughts and the markets became more confused. Each FOMC member seems to analyze the data and come to a different conclusion about the timing of a move to raises interest rates. Minneapolis Fed President Kocherlakota went from being considered a hawk two years ago when he proposed an initial target of 6.5% unemployment. Now he has moved his target ever lower and would prefer to wait until the economy runs a “little hot.”

After the Fischer speech at Jackson Hole, this Friday’s unemployment rate has taken on added importance. If the NFP is 235,000 or higher, in line with the six-month average, the FED would appear to be comfortable pushing the FED FUNDS higher. Of course, that would presume that average hourly earnings also increased, even if only by the consensus level of 0.2%. If we listen closely to Stanley, it seems that the FED is desirous of lifting its official rate to a minimum of 0.25%. This is what Fischer believes. But is he in lock step with the Fed Chair Yellen? Many analysts think the two agree but I am not at all certain. It was Fischer who won the day in removing “forward guidance” from the FOMC statement but in some Yellen speeches since its removal there has been a hint of an “extended period.”

Again, I am in the camp that there is dissension between the Fed Chair and Vice Chairman but I can offer no proof  other than analysis of speeches and commentary. But if the jobs data proves more robust than consensus I would believe the Fed Chair has prevailed in the policy discussion but of course the vote OUGHT not be the regular unanimous or lone dissent. August has been a trying month for all investment classes so the market will be cautious going forward into the uncertainty of Fed policy but there will be some keys to watch:

1. In light of a “hawkish” Jackson Hole statement from Fischer the, U.S. dollar failed to rally. If the FED raises rates and the dollar fails to rally in the subsequent days, it will be a sign that the markets have anticipated and replied: Is that all you got? As that great boxer Mike Tyson said, “Everyone has a plan until they get hit in the face”;

2. Does the yield curve flatten or steepen following a rise? If the curve flattens then the Fed erred in rising rates as the forces of deflation are more worrisome than fears of the FED being behind the proverbial curve. However, a rise in the long-end greater than the short-end would signal that the markets believe that the FED is one and done until it sees its dual mandates met. In a corollary to this ,if the yield curve were to steepen any equity selloff will be short-lived as the stocks will celebrate the Fed moving to the sideline. Steepening curves have initially been bullish for equities although I can’t provide a time frame for its duration;

3. If the precious metals rally post-strong nonfarm payrolls and FED hike, greater forces in the global economy will prove to be at work. There is discussion about the FOMC hawks getting their desired hike but then the FED will have to do an about-face and undertaking QE4. I find this to be of great speculation at the moment but it is circulating. August is over. September is here and at this stage the SPOOS are lower on the year, the U.S. dollar is stronger against a basket of currencies, 30-year bond yield is moderately higher and commodity prices are significantly lower. China is slowing. Japan is stalling. Europe is celebrating less than 1 percent GDP growth.

The U.S. is thought to be the global locomotive but with just over 2 percent GDP growth it is a very slow economic train that it can pull. In a zero interest rate environment equities have provided shelter from the financial repression of central bank omnipotence. But if corporate profits are brought under pressure from the threat of Chinese currency depreciation the global equity markets will be hard pressed to sustain somewhat stretched valuations.

Just a quick view into the autumn /fall that awaits us. Step back and take a measure of where we are for the year  and how hedge funds and other investment elephants have performed. If the largest players are struggling volatility will increase as the search for a positive year-end quarter becomes paramount. Be prepared is the successful investors battle cry.

 

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8 Responses to “Notes From Underground: The Fed Moves From Wall Street to Madison Avenue”

  1. Alex Says:

    With or without fund performance, volatility isn’t going away for the rest of the year. In fact, I can’t see it going away for years!

    Not a bad time to be a trader!

  2. asherz Says:

    I find all this parsing of every word regarding interest rate change by various Fed representatives risible. If you listened to Fischer’s comments (and I think this interview was most important and represents Janet’s opinion and he was her spokesman), we at some point will get one or two .25 increases and then done for a long time. And the only reason for any increases is to give the supposedly confused Fed some credibility as they have been hinting at an increase which gets postponed. The straw house they perceive has the wolf (bear)huffing and puffing threatening to blow it down. The fragility will prevent any real interest rate increases and the statements by the various Fed spokesman are thrown out to keep everyone guessing. Look at what they do, not what they say.

  3. arthur Says:

    Thanks, Yra. As Druckenmiller said, I don’t know whether we’re going to end… I really don’t. But neither does the Fed.” Or Charlie Munger, I don’t know what’s going to happen. I regard it all as very weird. Anybody who is intelligent who is not confused doesn’t understand the situation very well. If you find it puzzling, your brain is working correctly.”

  4. Michael Greenberg Says:

    Actually, he said: “Everybody has a plan until they get punched in the mouth.”

  5. yra Says:

    Asherz—if the FED is playing that game and I am not saying there not because it is all conjecture especially my view that Yellen and Fischer are not in sync it just solidifies the point that the concept of central bank omnipotence has reached its end—if central banks have to spin everything to manipulate markets flooded with the liquidity they provided the straw house will be shaken by more then the PIIGS–but then I think we have agreed on this for the last five years.But again I think Fischer and Yellen are not one of the same and have different views —it was a mistake to appoint Fischer –can you imagine if Summers was Chair and Fischer was vice -chair

  6. asherz Says:

    Yra- The Fed went on this mistaken journey banking on the Wealth Effect to solve the broken financial system. They created assets that inflated but it didn’t trickle down to the hoi polloi (the 90%) but bloated their balance sheets, and globally $57 trillion in new debt has been created.
    Fischer and Yellin may have some differences in style and presentation, but in the essential policy of raising rates do you think there is a real difference? I think token increases if any are the only path that is open to the bunglers.
    Just read the Rotten Heart of Europe over the week-end and thank you for that recommendation. Our financial future in the hands of the incompetents in Brussels and Washington mayhave lead us to the destruction of the most successful; system as Adam Smith saw it centuries ago. The invisible hand was replaced by the heavy-handed bureaucrats that have been experimenting with theories that can only be described as crackpot.
    The Mullahs and Commissars are rejoicing.

  7. yra Says:

    Asherz–yes indeed and I am not sure that yellen are in the same hymnal—I deeply believe that she would prefer wage rates to rise as she espoused when she did that ridiculous show in Chicago when she was busy cavorting with the underemployed and mentioning by name—but whatever it is certainly not a key part of the problems facing us–and the portfolio balance channel was nice while it worked and kept prices elevated in the Hamptons

  8. Chicken Says:

    FED should raise rates b/c the US recovery is making too much progress in comparison to emerging and developing markets.

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