The market is in disarray as it anticipates tomorrow’s FOMC statement. Will it lean dovish? The turmoil in global markets is having negative impacts on capex and the wealth effect as global equity markets have dropped considerably since the December 16 rate increase. Do I believe that the 25 basis point rise is the catalyst for the destruction of household wealth? NO. But the FED is confronted with a worsening condition in terms of TOO MUCH DEBT IN A DECLINING PROFIT ENVIRONMENT. As Michael Pettis, Felix Zulauf and others have postulated for a very long time, too much debt on a balance only matters when the debt can’t be serviced. Zulauf and Jeffrey Gundlach have voiced concerns about the FED being irresponsible for raising rates as the global economy slows. Art Cashin, the great voice of reason and stability, has been on record for weeks predicting the FED will lower rates to ZERO before the market ever sees ONE PERCENT.
Vice Chairman Stanley Fischer has recently stated that he believes that the market is WRONG about FED projections and that FOUR RATE HIKES ARE IN THE BALLPARK.We have not heard from Chair Yellen in a while but long-time readers of NOTES FROM UNDERGROUND know my thoughts: Janet Yellen is a labor economist and moral philosopher and leans toward wages rising before the FOMC moves too aggressively to curtail any positive benefit to the jobs and wages situation. IF HIGHER WAGES COME AT THE EXPENSE OF CORPORATE PROFITS SO BE IT. I have maintained that unlike previous FED chairs she is not desirous of being beloved by Wall Street .Higher wages in a low productivity economy have to be realized at the expense of corporate profits.
If the world is on the precipice of another DEBT crisis–as Gundlach and Ray Dalio are maintaining–a dose of inflation would help ease the burden of potential balance sheet contraction. So if Yellen is going to soften the FOMC‘s Summary of Economic Projections–the never correct DOT PLOT–she is going to have to paint a bleak picture of economy. And not the domestic economy but the GLOBAL ECONOMY. The problem for Yellen is that she relies of the Fed’s DUAL MANDATES so the Fed’s rationale for any dovishness will have to be crafted in terms of global headwinds causing severe problems for the U.S. economy, including the deleterious effects of an overly strong DOLLAR. I went back and reviewed FOMC statements from 2014-2015.Here is what I found:
1. In all of 2014, the FED did NOT ONCE MENTION INTERNATIONAL DEVELOPMENTS. It was not until the FOMC statement January 28, 2015 that the Fed said: “… and readings on financial and international developments.” The reference to INTERNATIONAL DEVELOPMENTS appears in all the 2015 FOMC releases. The most interesting is that in the December 16 statement when the FED lifted the FED FUNDS RATE there were TWO references to international developments. Also of interest is that in 2014 the Fed was concerned that “fiscal policy is restraining economic growth.” The concern about the drag caused by lack of fiscal stimulus disappears in the October 29, 2014 statement and has not been referenced since;
2. MY TAKE IN ALL OF THIS IS THAT IF YELLEN WANTS TO SOFTEN THE FED’S STANCE IN RESPONSE TO GLOBAL FINANCIAL STRESS THERE WILL BE FAR MORE THaN THE LINE “READINGS ON FINANCIAL AND INTERNATIONAL DEVELOPMENTS.” If the market wants the FED to be dovish, then the statement itself will have to contain many references to global finances and the possible headwinds from a very strong dollar. Also, if the FED wants to soften the December statement they may restate their concerns about the DRAG from the lack of fiscal stimulus;
3,Stanley Fischer may opine that the markets have it wrong but it is still the Yellen Fed. There are four new voters this time and Cleveland’s Loretta Mester and K.C. Esther George are noted HAWKS. A unanimous vote with Fischer, Mester and George voting with Yellen that may also be interpreted as a softening stance from the zealousness of the DOT PLOTS. It seems that Yellen will want to PAINT A DISMAL PICTURE OF BLACKENING STORM CLOUDS. Otherwise, the four rate rises the Fed predicts will be in the ballpark.
***One final consideration: Is the current flattening trend in the 2/10 yield an ominous sign portending black storm clouds for the global economy? The curve has now closed under the 117 basis point level dating back to July 2012 and as a reader Karl pointed out, yesterday’s close was the flattest close in more than five years. The action in the curve OUGHT to signal to the FED that maybe the MARKET is correct and the global headwinds are a force to be heeded.
Also, the GUNDLACH argument. If the FED is deemed to be leaning “dovish” the curve OUGHT to steepen with the TWO YEAR NOTE RALLYING THE MOST. Today the 2/10 curve traded down to 112.86 basis points but steepened toward close to 115.75. If the curve closes below today’s low after the FOMC statement it would signal danger signs and will try to test the major levels of support at 75 to 80 basis points. If Gundlach is right and Fischer wrong it will be a black picture as TEARS GO BY.