Fed’s True Colors
The Russell remains one of the best indicators of general market order-flow. I believe coupled with the bond market has been the best indicator of future Fed monetary policy. The bond market rallied, sending rates below 2.2%, that was the first sign the Fed was not going to raise rates or become Hawkish. Earlier this week the Russell’s decline slowed and built support and began to rally as the rest of the narrower indices continued to see volatility. However, let me be the first to say we are not out of the woods yet; we still have over a week before the FOMC meeting.
Fed’s True Colors
The Fed’s True Colors are shining through. As we have been tracking the Fed’s policies, the shift in power from the President Obama appointed Chair and governors, the Fed minutes, the changes of target rates, the bond auctions, and the math of interest rates / debt / deficits it is clear the Fed has shifted further into the accommodative camp.
Courtesy of wikipedia
In Heller’s famous book he introduced a paradoxical situation, dubbed “Catch-22″. It is a situation in which one cannot escape because of contradictory rules. It the book a WWII pilot said he was crazy to try to get out of flying dangerous missions, but if one was concerned for his safety then they can’t really be crazy so he would have to fly. However, if he was to fly the mission he must be crazy because it was dangerous.
The Fed is facing their own Catch-22; they can’t end accommodation until they raise rates to attract buyers of bonds at higher rates. However if they raise rates, they must increase accommodation because government’s interest on debt would increase and thus increase the deficit.
This of course is just the results of artificially fixing interest rates at zero and monetizing government deficits (buying bonds). In some respects the Fed is stuck and this has nothing to do with their dual mandate of “unemployment” and “stable prices / inflation”.
The Fed has already tossed out the target rates for unemployment. Bernanke had set the U3 unemployment target rate at 7%, at which point the Fed would end QE and start raising rates. Well we hit that level and Bernanke moved the target to 6% and maintain accommodation. Now we hit 5.9% on the U3 unemployment rate, but the Fed has not ended QE or raised rates.
Yellen knew early on that the U3 rate was not accurate and setting it as a target would mean always moving the goal post. Yellen had taken a pre-emptive strike and in the Fed minutes and FOMC statements earlier this year she laid the ground work that they would not use unemployment target rates anymore. The Fed has pretty much tossed out the U3 rate as a target, yet it continues to be the “official” rate of unemployment and you still hear Fed officials and politicians refer to it. Frankly any reference to it is just disingenuous, if it is not good enough for the Fed to set as a target and a measure of the unemployment to set monetary policy, then why should any of us pay attention to it?
The CPI, “official” measure of inflation, had climbed over 2% for a short while and again the Fed started moving the goal posts. Yellen and more recently Charles Evan (Fed President) stated that 2.5% should be their objective.
So the Fed has removed any measure of unemployment to set policy and the top-end target for inflation is now becoming more arbitrary. So targets are NOT being used to determine or set Fed monetary policy, because frankly the targets don’t actually measure inflation or unemployment very well at all.
The Fed policy has not budged since the beginning of the year. Yellen took the helm from Bernanke and has just kept the ship on course with no changes to rates and no changes to the current slow taper. The course of this ship was to reach its destination in October. At which point the Fed policy would change – the end of accommodation.
As we get closer to the supposed “End of QE” and the beginning of rate hikes, the market has come under panic. Much like it did at the end of QE1 and QE2. No real surprise.
Devaluation Currency War
Meanwhile the Bank of Japan (BOJ) and the European Central Bank (ECB) have taken the exact opposite approach. They are ramping up their QE policies and lowering rates further.
This wasn’t a surprise, the Federal Reserve knew about the ramping up of the accommodation from the BOJ and ECB. In fact we did as well as the leaders of those central banks had announce such policy shifts.
The Fed stayed the course of the taper and talk of raising rates, the expectations is the dollar should rally. This is simply a function of Supply and Demand. We have seen the results of this currency war, the dollar is rallying and the Euro and Yen continue to decline. This again is no surprise.
Unfortunately, this is the exact opposite results of what the Fed wants. Based on the CPI model we are facing DEFLATION and wider trade deficits.
The dollar rally has had a significant benefit to U.S. consumers. Higher dollar prices have increased buying power for consumers. Oil prices have come down and that means gas prices are coming down. It also has slowed the rise of food prices. Some have said the strong rally in the dollar is like giving a huge tax cut, as buying power has increased. This can certainly help boost confidence among consumers heading into the mid-term and right now the Democrats need all the help they can get.
Fed shows their true colors
Courtesy of wikipedia
Cyndi Lauper would probably do a better job running the Fed, well probably not – but at least we would know her true colors.
The Keynesians in the Fed certainly don’t like a strong dollar, but remain masters of double speak. They try to hide their true colors, but it keeps shinning through. The strong dollar has a benefit of creating optics for policy justification. The strong dollar is creating deflationary pressures and has lowered the CPI. That is great news for Fed members that want to continue to QE/accommodate policies and zero interest rates. The drop in the CPI gives them something tangible to point to and justify more accommodation. Who is going to question the “official” measure of inflation?
Recent Fed Statements:
October 8th: Charles Evans (Dove Fed President) mentioned more accommodation and higher CPI targets at 2.5% = market rallies.
October 16th: James Bullard (Dove Fed President) stated he would consider continuing QE after the October FOMC meeting = market rallies strongly.
October 17th: Eric Rosengren (Dove Fed President) stated on CNBC that if the economy got weak enough – it would require more QE = pre-market futures rally.
October 17th: Janet Yellen (Dove Fed Chair) states she is very concerned about income inequality. Believes that Fed policies so far have helped families and lowered unemployment.
James Bullard – courtesy of wikipedia
The last FOMC statement clearly mentioned concerned about the “structural unemployment” and “slack in the labor market”. The minutes released from the meeting was also move dovish, with concerns about deflation and the strengthening dollar, that could impact 3rd and 4th quarter GDP growth.
Market’s Catching On?
While we still have some time before the next FOMC meeting, I think the market is starting to catch on that the Fed is govern by Dovish Keynesians that believe in their accommodation policy and believe that the current policies are here to stay.
The pre-market futures are rallying again.
Support & Resistance
We could get back up to the 16,400 area and see some selling pressure in that range before the FOMC meeting. Expect some more volatility.
This is the previous break-down support area, we could see some resistance in there. Continue to expect volatility for now.
Much like the other indices I think we could see a rally to this level before we see selling pressure return. The VIX should get back down into the 18-20 range today if we sustain this rally, however – don’t expect that volatility will end yet.
We hit that 1050-1060 support area and rallied. I think we may seem some resistance up in the 1100 area, but if we can gain that area and put in a support it may help calm the market as it shows order flow returning back into the market.
Fed are Doves – get over it!
I am not sure why so many economist and analyst expect that the QE and accommodation would end and rates would start going up at this next meeting in October. The mid-term alone should be a clear signal that the President appointed Fed would not want to shake up the market and the economy right before the mid-term election.
Even without the mid-terms; statements, dropping target rates, and the math shows that rates are not going up soon and accommodation based on the bond auctions is here to stay for a while longer.
Lastly, the market, after 6 years, feels entitled to cheap money – you can’t take it away.