Notes From Underground: Take Jerome With a Big Grain of Salt

A quick view on Wednesday’s FEDERAL RESERVE‘s meeting: According to the newest Fed stenographer, Nick Timiraos, look for the central bank to raise rates 75 basis points in an effort to get ahead of the curse of HEADLINE inflation. This level is baked into the present market values. Look to see if there is any discussion of slowing the FED FUNDS increases as the FED tries to get a handle on the impact of $95 billion a month balance sheet unwind and a DOLLAR that has risen 14% since the beginning of the year, and more than 20% versus the Japanese yen.

Outside the US borders, the global economy is slowing and the stronger dollar and its influence in financing global finance is promoting a high probability of tightening financial conditions causing great stress for many dollar-dependent nations. If the consensus for an increase of 75 BASIS POINTS is correct look for the FED TO BE EXTREMELY HAWKISH WITH ITS USE OF THE DOT PLOTS. That’s the tool the FED has used to provide FORWARD GUIDANCE FOR MANY YEARS. The central bank has maintained that they would move away from FORWARD GUIDANCE but its use is too valuable a tool on a cost-benefit basis.

In Tuesday’s Wall Street Journal Timiraos provided a key to Powell’s strategy. He wrote, “On Monday, investors in interest-rate futures markets saw an 82% probability of a 0.75-point rise and a 18% probability of a full-point increase, according to CME GROUP.” In the following paragraph Timiraos said: “EQUALLY IMPORTANT WILL BE SIGNALS FED OFFICIALS SEND ABOUT HOW MUCH HIGHER THEY EXPECT TO RAISE RATES,AND HOW FAST THEY EXPECT TO DO SO,AND WHAT THEY EXPECT THE ECONOMIC CONSEQUENCES TO BE.”

This is critical for the POWELL FED that prides itself on getting a great deal of bang out of its communications. Think back to how Powell et al prided themselves on preventing a crash in the corporate bond markets in March 2020 by claiming to purchase a huge amount of debt. A lot of jawboning  with little capital did the trick. BY making the DOT PLOTS very HAWKISH going forward they may get the outcome without having to raise rates as high to levels that some are desiring.

There will be many questions from the press about the DOT PLOTS and that will garner the headlines that drive the algos. If the yield curve steepens, assets rally and the metals find a stem their decline, the markets will have read the potential reticence of Powell, especially as the November midter elections loom. Powell is all about more bang for the buck. In June 2021 it was Powell who said “Take the FED’s DOT PLOTS WITH A GRAIN OF SALT.”

In elucidating his comment, Powell maintained the FED DOT PLOT is not a great forecaster of future rate moves. Be patient with your trades as the markets will be very volatile during the press conference. My over/under on dot plot questions is FOUR.

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17 Responses to “Notes From Underground: Take Jerome With a Big Grain of Salt”

  1. Asherz Says:

    If raising interest rates is the WAR on inflation, what we are seeing is “”Jaw jaw, instead of War war”, as Churchill said. Yes short term War but the main weapon is Jaw. One to three more interest rate raises leaving FF in deep negative interest rates.

    • David Richards Says:

      Asherz – Yes, the Fed is backed into a corner such that jawboning is mostly what they have left for the WAR on inflation, especially given the current ratio of federal debt to GDP at 130% versus 30% in Volcker’s day. Can’t raise interest rates without bankrupting the USG and the Fed… Ofc, the Fed and USG don’t really go broke but see Harris Kuperman’s good article this week about how Fed rate hikes bleed the US Treasury to keep the Fed “solvent”, oops:

      Also, yes indeed, even if those remaining 1-3 rate hikes you cite were to be 75 points each as seems unlikely high, the FOMC terminal point will still be a negative real rate. Especially if inflation remains stickier than most expect, as I think it will due to:

      1) In the short term, the inflationary housing component of US CPI substantially lags in the BLS CPI calculation;

      2) In the medium to long term, the US pressing a reshoring policy onto itself will cause high inflation & shortages in the US similar to Europe’s energy policy in Europe (did anyone else notice the German 46.5% PPI inflation print earlier this week?);

      3) Mass psychology is embracing higher inflation expectations, which becomes a self-fulfilling prophecy as people begin to hoard, buying all they can today before prices rise tomorrow;

      4) Inflationary public fiscal policy is entrenched with stuff like stimmys & debt relief (banks, corporates, students, gas/energy, and next maybe credit card & mortgage debt), and legislation like the inflationary Inflation Reduction Act and out-of-control public spending on that and also expensive foreign wars financed mostly by debt that now increasingly gets monetized (refer to the Great Society and Vietnam era to see the damaging macroeconomic effects on what was then a much stronger/healthier US economy than now);

      5) US wage-price spiral is already underway, which is hard to stuff back into the bottle… did everyone notice Biden’s 24.5% pay increase (plus generous signing bonus) for railroad workers last week? I’ll bet many US workers noticed and they’ll reference it as a new benchmark for themselves. THIS is probably an inflation inflection point (higher), like how Reagan firing the air traffic controllers rather than acquiescing to their pay increase demand 41 years ago was an inflation inflection point lower.

      Note: NOT making any political statements, just some macroeconomic observations.

      • David Richards Says:

        In item #1 above, I’m referring to the “owners’ equivalent rent of residences” component. It’s too long & geeky to explain here but anyone interested can google it for more info, so suffice to say it’s a large and lagging component of the CPI calcution that should keep CPI elevated into next year even if real prices abate (as home prices reportedly are).

  2. David Richards Says:

    Yra, in keeping with your title here about taking it with a grain of salt, here’s more that’s especially salient I think.

    Apparently, we should also take with a grain of salt what they say about QT and the Fed balance sheet runoff.

    In the previous thread, I commented that the Fed already pulled back on MBS, probably due to the weak housing market in the US (and in much of the world) especially for new homes. I speculated whether the Fed might also throttle back on Treasury QT too in view of several poor Treasury auctions that recently occurred.

    So on Monday, we got Hedgeye (financials analyst Josh Steiner) confirming that based on Fed data, the Fed has actually INCREASED its balance sheet (“BS”) during the first half of September. So the Fed has actually done some QE month-to-date, not QT.

    Specifically, instead of letting the Fed BS runoff at the expected rate of $47.5B for the first half of Sept (47.5B is half of the $95B monthly BS runoff rate that the Fed committed to starting Sept), the Fed BS rose by $1-billion during the first half of Sept.

    Further, for the previous 3 months, the actual Fed BS runoff was less than half of the previous slower pace of $47.5B per month that the Fed had announced.

    So is Pinocchio in the house?

    Here’s a good, 4-minute clip from the Hedgeye guys (who I think are often pretty sharp) detailing this QT issue:

  3. Richard H Papp Says:

    Simon White of Bloomberg quoted an old friend Bob Farrell (a Manhattan College Graduate) of Merril Lynch
    “When all the experts and forecasts agree, something else is going to happen”
    That is what i feel about the current state of “STUFF”

    • David Richards Says:

      What about the “Fed pivot” that everyone expects is inevitable (just a question of “when”), and how it’ll certainly juice all asset prices?

      • Richard Papp Says:

        Robert Rhea and Richard Russell two Dow Theorist from the past have frequently said: “What everyone knows ceases to have an effect on the market”

      • David Richards Says:

        Ok, so then here’s a hypothesis. Everyone knows that the FED will eventually pivot and then asset prices will go to the moon. Everyone is waiting for that event to plunge in and get rich. But per Bob Farrell’s adage, the consensus opinion means something else will happen. But what?

        Well, I think that like with the Fed pivots of 2008 and 2001, after the FED PIVOTS, asset prices instead will *accelerate* their decline (after an initial kneejerk positive market reaction, to be faded). Because the majority must be wrong (and Mr Market does what pains the most participants), so eventually the narrative will become “OMG the FED is panicking as they know something bad that we don’t”.

        But the FED doesn’t know anything. They’re incompetent instead of insightful. Their forecast a year ago when inflation was approaching 5% and rising was that inflation would be 2.4% now, a year later, not 8.3% like reality. So their forecast was off by only 250%, bad enough to get most people fired but not anyone from the FED.

        The FED nowadays is often behind the curve & reactive instead of proactive. They cut interest rates into an expansion and they hike interest rates into a recession (like the US is already in now for the 3rd consecutive quarter as we shall soon see with the 3Q data, with more recessionary quarters to come for sure this fall-winter too).

        But as per this blog title, please take all I write with a grain of salt because I know nothing.

  4. Pierre Says:

    Maybe a more appropriate wartime quote would be:
    “Damn the torpedoes! Full speed ahead.”
    David Glasgow Farragut

  5. David Richards Says:

    On this topic of the Fed, below is a link to a fairly interesting free piece three days ago by Chris Whalen (Institutional Risk Analyst) about the history and present bind of the Fed and how it got here. In his view, the Fed has failed, and the employment mandate is both problematic and bad policy. He says a lot about Volcker, Powell, and the Bernank & Yellen.

    For example, this piece notes how Volcker rebuked Yellen & Bernanke in a 2018 Bloomberg essay:
    “The real danger [of a critical breakdown of the financial system] comes from encouraging or advertently tolerating rising inflation and its close cousin of speculation, in effect standing by while bubbles and excesses threaten financial markets. Ironically, the ‘easy money,’ striving for a ‘little inflation’ as a means of forestalling deflation, could, in the end, be what brings it about.”

    Whalen also doesn’t pull any punches about his views of Vocker’s shortcomings.

    “Inflation, Politics & Fed Chairmen”

    A link at the bottom goes to a discusion of Volcker’s rebuke of Bernanke and Yellen a year before his death.

    • Yra Says:

      David—-have that Volcker oped piece sitting next to me—-it was funny as I downloaded it on Monday in a discussion with Whitewave-as that piece admonished the Powell Fed for its enslaved attitude to the 2% inflation target–October 24,2018—and interesting in Powell’s response to the FT s Colby Smith and the 2.1% 2025 dot plot inflation Powell waved it off even as Ms.Smith noted its importance —exactly what Volcker warned about on the downside and even more so the Whalen piece was soooooooooooo gooooooooooooood—but as you are aware with will KEEP AT IT—our criticism of the FED that is—-interesting that not one journalist asked if the FED was responsible for the current inflation problem.Certain MSM financial journalists need to retire as it was Politico and Axios that asked the most pertinent questions——-have much more to say but the curves closing on there lows [most inverted ]set the game for the crushing of the equities —Kashkari and his pals drinking DOM tonight

      • David Richards Says:

        Yra, did any reporter ask what happened to the $95B balance sheet runoff that’s supposedly starting in September? LOL

        I heard that the most common question was, when-oh-when will IT (the rate hikes) stop please? Hint: the answer is in the book “Lords of Finance: The Bankers Who Broke the World”, as history rhymes if not repeats. As we don’t learn from history. Ditto for the war that’s brewing. Sad.

        Prediction: Folks will get their pause and pivot that they’re clamouring for, but they’ll dislike the eventual knock-on consequences.
        Prediction caveat: All I bring to the discussion is decades of mistakes.

        As for the curve inversions, some of which I believe are now at record inversions in both the EU and US, I heard that J-Pow said that doesn’t matter?

        If you’re familiar with Hedgeye’s Neil Howe’s concept of the so-called “Fourth Turning” generational theory, which we’re now in, then you’ll know one of its characteristics is the eventual end to numerous institutions that were created and key in the earlier turnings. It’s looking like the FED might well be amongst those institutions to end in this Fourth Turning.

        Interesting times, in a cursed way.

  6. Chicken Says:

    “A big slowdown in the economy is coming, with rising unemployment.” – J Powell

  7. kevinwaspi Says:

    Excellent points all. I too can see an eventual pivot, (especially since it’s already started with the absence of QT), that will precipitate market panic. This may be driven by a huge Japanese Yen bust, as being short energy, aging demographics, and that indebted leaves little room to maneuver.
    Yes, markets tend to make fools out of the majority. I’ve told many over the years, “Every time I get the key to these markets they change the locks.”
    Best to all of you.

    • David Richards Says:

      Kevin, I think Japan is simply ahead of the monetary curve as it has been for many years. First to do QE, which the rest followed, and first to do YCC, which the BOE followed today, as the rest will too before long (within weeks or months).
      On the positive side for Japan, it’s a twin surplus country and it now has the energy advantage over the UK-EU, whose industrial lunch Japan is in the early innings of eating, I think. Japan is short of energy, yes, but nevertheless now enjoys a relative cost & supply advantage as they source a substantial & growing chunk of their oil & gas consumption from Russia at a price discount in non-dollar payments, especially since increasing their import of Russian LNG by 200% in August. Likewise for Japan’s import of enriched uranium from Russia (who accounts for almost half the global supply – so not sure Europe and the West ex-Japan have figured how they’re gonna power their nuclear power plants).
      So if forced to choose, at this point I’d bet that USDJPY, currently 145, reaches 120 before 160, and I’d be long Japan versus Europe. But let’s see.

      • Asherz Says:

        We knew the pivot was inevitable, ( I was saying November or December), but not this quick. When the choice is Hyperinflation and destruction of currency, or Deflation and the Greatest Depression, which one will the Central Bankers choose? No doubt the former. Does anyone think Andrew Bailey did this on his own without talking to Powell and the other Lilliputians? All coordinated. And how many Fed Governors went long the market Tuesday afternoon? I wonder if Pelosi was a fly on the wall. As said above, Jaw, Jaw rather than War War as Winston said. And the weapon of choice is Jaw. But now the emperor’s clothes are off for all to see. The paper gold manipulators will keep trying to play their game, but the end is not far.

      • David Richards Says:

        First, it’s sad how we now know that speculation about insider trading of FOMC decision makers is more than mere cynicsm (same for the Speaker). It’s real Fourth Turning stuff. Neither the Fed nor Pelosi may survive it. Alas they’re not going to prison tho.

        And yes, we know the end game is currency destruction and high inflation. But timing is the tricky part and it won’t be a straight line. The Fed isn’t the BOE, at least not yet. The US is strongest and because the Fed was properly humiliated about transitory inflation, jerome isn’t necessarily ready to pause, never mind pivot, quite yet. October is still a blackout month. The MOVE and equity volatility indices are still elevated. So IMHO sometime next month US stocks & bonds will probably print new cycle lows. BICBW.

        But generally I completely agree with the overall themes of your post(s). And I think that gold & miners, about the most despised asset currently, is setting up for a legendary run. Its paper price manipulation, as has been evident and recently admitted to, has the physical gold price held below market value like a big ball held underwater, like how the gold price was held submerged in 1971 (I lived it).

        But most real assets of value should outperform going forward, relatively. Maybe even the beloved shitcoins too, but me being 84 years old, I don’t understand those and never owned a single one. If I did, I’d probably forget my password or misplace my floppy drive and smartphone or whatever they need to work, and thus lose all my investment. Besides, I hate smartphones like I hate paper gold. I prefer things real. Like market-based pricing instead of Fed central planners’ pricing. All this government intervention of various markets by the likes of jerome and sloppy joe just creates bigger problems later… and they’re taking us to war, too. Eventually there will be blood in the streets.

        – Grampa Richards

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