Notes From Underground: Will Janet Yellen Paint It Black?

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.

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11 Responses to “Notes From Underground: Will Janet Yellen Paint It Black?”

  1. the american limey Says:

    From previous blog.

    how many bets on dovish fed bump up 1.5 – 2sd to SPX 1930 – 1940 tomorrow. SO my strategy, read guess, is to wait for 1940 ish and go short /es back down to 1888.

    Come on chaps ( not the sterling transfer guys) place your wagers. I’m wondering if someone breaks ranks and says “an ill favored east wind is blowing and we are overtly overmasted ( nb speedwell)” wouldn’t it be nice if FOR ONCE they didn’t play Sir Humphrey’s and came clean.

  2. Anthony Says:

    It seems to me that the Fed recognizes that we are in a worldwide currency war, but with their balance sheet at 25% of GDP, they cannot fight it by conventional means(more QE). The only way to get the dollar down against all currencies, while maintaining their credibility, is to pop the equity and bond bubbles. While this doesn’t solve anything, they have gotten themselves into a situation that has no solution. After the crash, maybe they can claim they acted responsibly by raising rates and the $1 trillion plus deficits are a fiscal policy issue. Maybe people will be stupid enough to believe them and the institution will continue to exist?

  3. Frank C. Says:

    it well known that Janice Yellen arrives three hours early for a plane flight. This should tell you her personality is extremely cautious, guarded and risk averse. She is more of the old school marm type. I believe she is afraid of disrupting the economy and hurting individuals of lesser means.

    It is Stanley Fischer who is the more assertive personality. He recognizes that QE is a failed policy. And that the long term effect of ZIRP gives you Japan redux. He has an opportunity to raise rates and does not believe that 50 or 75 basis points affects borrowing or debt service capacity. In fact the flattening of the curve is one of the few times the Fed can affect the long term end of the curve. Banks and insurance companies and pensions need higher rates. Savers and retirees need higher rates. He also bifurcates the oil economy from the rest of the US economy. And letting some air out of the stock market bubble isn’t so bad.

    If an additional 75 basis points this year is the demise of the US economy he isn’t buying in. And rates going back to zero or negative 50 bps won’t help the oil patch or their junk bonds.

    Lastly no change in rates here will help China climb out from their over capacity and ponzi bank debt scheme.

    If the financial apocalypse come at 50 bps or 75 bps fed funds than what does the future really hold.

    To me what has changed structurally is the market recognition that QE 2; 3 and 4 did not work in the US, Europe, Japan or any where else. QE 1 initially worked in America and Europe, but it has greatly lost its potency. Everyone now accepts that.

    Let’s get away from Fed manipulated market and back to laissez faire economics. Normalization of interest rates are the free market.
    And if stocks decline so be it.

    I think maybe Janice is thinking I Can’t Get No Satisfaction. And Stanley is in singing You Can’t Always Get What You Want.. As for me it looks more like the opening lines to Gimme Shelter – “Ooh a storm is threatening.”

    • yra Says:

      Frank–so very well done –and good points but Janet’s cautious side is stilted to the coach section and the the early arrival is to inspect the working conditions for the ground crew and flight attendants—-major janet to ground control–allow me to introduce myself

  4. Chicken Says:

    The US FED is the best money can buy!

  5. Dan DeRose Jr Says:

    Yra, Excellent post as always! We sure are at an interesting juncture. I agree Janet is a labor economist but I wonder if that means she’ll react with the same trepidation as her predecessors to market turmoil. With corporate profits 70% above the historical mean, it’s labor that has been getting screwed, as you say. If Janet believes in sticky wages, maybe macroeconomic turmoil won’t be a game changer so easily. Throw in research on how inequality effects demand (link below) and suddenly her react function might operate with quite the lag.

    http://blogs.lse.ac.uk/usappblog/2015/07/13/rising-inequality-is-holding-back-the-u-s-economy/

    Also, you shouldn’t see any mention of fiscal policy tomorrow as the deficit is set to increase for the first time since 2009 as a percent of GDP. Dudley mentioned this positive factor during his speech on Jan 15, which, if you think about it, reads as if it was given Q3/4 of last year. Didn’t he know the markets were a mess?! Fischer can be forgiven on Jan 3 but Dudley not so much. It’s the lack of pivot with ample opportunity that leads me to believe tomorrow will be a reprint of previous statements. I don’t think the Fed sees or cares as much as they should (see: contained) about the risks that have macro investors aghast. Or, we should hope, they’re saving the few bullets they have left as wasting them now will not change the deluge pouring out of China or oil wells around the world. It may be a different story by the Ides of March.

    • yra Says:

      Dan–good thoughts and it is well noted on the fiscal side which is why they are so desperate to allow others to play that they maybe invoke fiscal policy back in the statement—–one bullet in the gun is only Chinese roulette

  6. Rob Syp Says:

    In these Looney Tunes times isn’t your best defense having a portion of your money in gold?

    Know you’ve beaten the horse dead about the fundamentals and technicals of the yellow metal but what else is there?

    Changing the subject do you ever comment on the grain market or soft commodities? Since this El Nino is working to a T and percentages say La Nina follows which would mean a hotter dryer summer in the States = potential higher grain prices.

    I bring it up only cause if everyone is looking at the same markets could it be time to look for opportunities in other markets.

  7. Chicken Says:

    Looks like the FED has “realized” their attempt at inflating another bubble is going over like a lead balloon.

  8. allen king Says:

    yra keep the good work up, we need to expose the people who play by there rule,that take away everything from us. thank you for fighting for us.

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