Notes From Underground

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.

Tags: Fed, Fed Funds, FOMC, GDP, Janet Yellen, Kocherlakota, QE4, SPS, Stanley Fischer

This entry was posted on August 31, 2015 at 8:12 pm and is filed under Uncategorized. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.