Notes From Underground

Over the last nine years, a major theme from the wit and wisdom of Notes From Underground has been that FED policy is not rocket science, the premise being that no matter how much math is applied the forecasting ability of the FOMC has been less than stellar because of the use of flawed models. Unlike genuine rocket science in which astrophysicists can land a vehicle on the moon and return the capsule to a pre-programmed landing site, the FED cannot predict the economy with any sense of proximity. Yet the FED built a massive balance sheet depending on those flawed models. The financial media was awed by the high maths of the FED‘s models so mainstream pundits offered little to no pushback, genuflecting at the altar of academia.

On Wednesday, Powell answered many of the questions by qualifying his answers with a reminder that FED forecasting has been weak in many areas. The primary concern of analysts was with the removal of the phrase “accommodative financial conditions,” which some traders deemed to be dovish. The dovish/hawkish argument is a false dichotomy for in my analysis this merely allows the FED to be flexible and not locked into a preset standard.

If tariffs, emerging market problems or a strong dollar prevent the FED from raising rates in December this gives them flexibility to respond to a change in data without spooking the market. By not remaining accommodative, the FED has provided room for maneuver. This dovetails with Powell’s speech at Jackson Hole in which he highlighted his desire to lead the FED with a risk-management based approach counter to the Bernanke/Yellen Feds’ reliance on economic models.

In response to Steve Liesman’s question about the dot plots and forecasting two years out, Powell stressed that it is “hard to be confident in projections going two years out.” Also, in a question about the impact of supply side impacts from the Trump tax cuts Powell admitted that the FED “is bad at forecasting productivity.” If that is indeed the case, then the FOMC has to be poor at forecasting INFLATION because so much of the projections are built on productivity outcomes. Again, it is refreshing to hear that this is NOT ROCKET SCIENCE.The problem is that so much policy has been based on flawed forecasts. The world has seen the world’s central banks buy TRILLIONS of DOLLARS of assets based on what Powell admits is flawed forecasts. Hallelujah.

In making the case why the removal of “accommodation” provides flexibility, I offer up the fourth paragraph from the FOMC statement: “In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. This assessment will take into account a wide range of information,including measures of labor market conditions, indicators of inflation pressures and inflation expectations,and readings on financial and international developments.” FLEXIBILITY!

***Bloomberg’s Mike McKee asked the question of the day (with the reporter from POLITICO a close second). McKee asked Powell, “Are the dot plots irrelevant?” Well, if the forecasting is weak why bother with the dot plots? Seems very logical but Chair Powell danced with his answer. The Politico reporter asked if Powell was concerned about high levels of corporate debt. I found Powell’s answer concerning as he went the Greenspan route and diminished downplayed any issues because he felt that the banks had distributed the risk throughout the system into many hands. HMMM.

The second question was if Powell had any hand in Trump’s FOMC appointments. Powell said no but it is an appropriate question based on Rick Santelli’s interview with Vince Reinhart earlier in the day, in which the pair noted the high quality of Trump’s FOMC appointments. I have been wondering who is providing the advice.

***I am offering up something for consideration. European Brexit negotiators have been intransigent in an effort to punish Britain for the temerity to vote to leave the EU. Prime Minister Teresa May has been backed into a corner, especially as French President Macron is trying to raise his stature at home by making it difficult for the U.K. German Chancellor Merkel has appeared softer as she tries to placate German industry with its massive exports to the Britain. (Germany runs a large trade surplus with Britain.) Prior to Brexit, Germany and Japanese automakers invested large amounts of money into developing auto production for export into the European Union. The benefits for Nissan Toyota, BMW and others is that by manufacturing in Britain these automakers had the benefit of a non-euro currency, as well as a long-established history of an educated workforce and respected rule of law.

The ability to export tax-free into the EU was the final benefit. President Trump has been at odds with President Macron and Chancellor Merkel so if Prime Minister May is backed into a corner look for President Trump to throw the Brits a lifeline by offering to craft a free trade association with Britain. The Germans and Japanese would get the benefit of free trade auto exports with the U.S. This is just something to consider as Brexit becomes even more contentious.

The situation becomes even more difficult for Chancellor Merkel because her closest parliamentary leader Volker Kauder was booted out of office. The coming Bavarian elections in which Merkel’s key partner, the CSU, is projected to be severely weakened for the first time in many decades. If Merkel is weakened in Bavaria watch for Trump to add political support to any political adversaries of Chancellor Merkel. Watch the EUR/GBP cross for any sense of Prime Minister May gaining leverage over the EU.

Tags: accommodative, Angela Merkel, Emmanuel Macron, EU, EUR/GBP, Europe, Fed, FOMC, inflation, Jerome Powell, Theresa May

This entry was posted on September 26, 2018 at 5:40 pm and is filed under Currency, Europe, Fed. 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.