Ultra Dovish Fed

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Today it is all about the Fed and Janet Yellen. The turmoil in the Ukraine has been ignored, Russia flexed its muscle and the US talked tough – game over. The recent economic data continues to draw a mixed picture about the economic recovery. It certainly doesn’t seem that the economy is getting bad; the problem is that it is not getting stronger or better on its own merits. We are coming to terms that the Fed monetary policy and government stimulus has been the core driver of the economic recovery, not the private sector. Now we will hear from the Fed

Ultra Dovish Fed

This will be the first Federal Reserve Open Market Committee (FOMC) meeting with Janet Yellen on her own as the new Chair of the Federal Reserve. We have been operating under Bernanke’s instructions up until today and the tone going forward will be crafted by Yellen.

There are several questions to which we will soon find answers, but we can take a look at the current Fed make-up to get a general idea of which way it leans.

Economic Theory

The FOMC is made up of a President appointed board of governors, combined with a few non-president elected Federal Reserve Presidents from the regional banks. The Fed Presidents are rotated as voting members into the FOMC, with a list of alternates.

Similar to political ideology between those that tend toward Socialism vs. Free Market Capitalism, the economic theory is divided as well between Keynesians (Doves) and Austrians/Chicago School (Hawks). I like to think that political ideology is the car and the economic theory is the engine. For Socialism and government expansionism to work you need an economic engine to drive it, the economic engine for Socialism is Keynesian. While the economic engine for Free Markets/Capitalism is Austrian/Chicago school.

Courtesy of South China Morning Post

Who are the FOMC members?

Much like our supreme court, the President gets to nominate the Chairman and the board of Governors for the Federal Reserve. Usually, much like the Supreme Court the board of governors serves terms that sometimes expand into another presidency and it is rare for a President to have the opportunity to nominate all the board of governors as well as the Chairman. Obama has been successful in stacking the entire board of governors and Chair with Doves and I would argue they are far more Dovish then the more centrist Doves and Hawks of the past. If there was one Dove that is more centrist, it would be Jerome Powell. The rest are ultra-Dovish, which is analogous to being on the Far Left if they were politicians.

Because the FOMC has a rotating membership for the Presidents, we have the opportunity to have a couple of none appointed Presidents who do not see eye-to-eye in political or economic theory/ideology. So we should see a more divisive Fed than ever before. However, it is important to remember that while they do VOTE, Monetary Policy decisions are NOT based on democracy. It is possible for the Fed Chair to make a decision the goes completely against the majority. Sure, they get to vote and voice their opinions, but in reality the vote can’t carry the day. Actually, to my knowledge (and limited research) we have not had a majority dissension, so I am not sure what would happen, perhaps a coup. However, none of that matters, the bench is stacked with Doves and Ultra Doves, so they will NOT vote against Yellen. The only two that will most likely vote against Yellen and are Fisher and Plosser; the other two Hawks will lean more centralist and will not rock the boat.

Taper or Not?

Yesterday I pointed out the most likely alternatives:

1. Taper Continues: This would stay the course with Bernanke’s $10 billion reduction per FOMC meeting. Asset purchases would be reduced from $65 billion per month to $55 billion per month.
2. Slow Taper: This would reduce the amount of taper to less than $10 billion. This would reduce the asset purchases to between $55 billion to $65 billion.
3. Halt Taper: This would freeze the taper and stay at $65 billion in Fed asset purchases and money printing per month.

Keeping with Bernanke’s policy would be the safest course, as it would keep the Hawks in check, it would not rock the market up or down and would give Yellen some breathing room. Based on government deficit spending, they could continue without squeezing government spending too much.

However, Yellen and her Doves want to INCREASE government spending and thus that would mean to reverse course and either slow down the taper or halt it all together. There is certainly enough economic data to justify a reduction of the taper. That means the probability of a slowing of the Taper is certainly high. The question is, how much would she slow the taper? If she slows it too much, it would certainly send the Hawks into a pissing match and the two Ultra Hawks would vote against it. However, the two centralist leaning Hawks would most likely go with the flow. The market could get a good boost higher.

A halt to the Taper is also in the cards, but probably less likely than a slowing or continuation. A halt would certainly send the markets higher with a knee-jerk reaction; however, it would also be sending a message to the world that the US feels they need MORE government aid and the economy is not as strong as we are being led to believe. It would also most likely have all four Hawks vote against it.

Courtesy of Christina’s Rate Roundup

Two options that will NOT happen!

There are two other very unlikely options. First, a FULL REVERSE COURSE, increasing the QE policy. At this early stage and her first meeting, she might even get some push back from Jerome Powell and even Jeremy Stein, who are both Dovish but I think would feel it is too early to let the dogs out. This is also her “Ace in the Hole”. In fact, heading into the mid-term elections I think this could be a higher probability, if it could boost economic activity that would favor the Democrats in the election. According to the Gallop and other polls, the economy and jobs are weighing on voters more than anything else. Making the economy SEEM stronger with a good shot of economic stimulus and more Fed money printing could be the medicine the Democrats need to sway voters in the mid-term to try to win back the House.

The other option, which is the most unlikely, is for her to INCREASE the amount of taper. I think Yellen would have an aneurism even considering a further rapid reduction of government asset purchases. In fact, this is exactly what Fisher and Plosser would prefer. They want the economy (for better or worse) to get off the government nipple and start trying to REALLY recover, as painful as that may be. There is no way that Yellen would increase the Taper by any significant amount and certainly she should would NEVER EVER just END QE in one fell swoop. Any increase in the taper, beyond what is expected and the pace that Bernanke started, would send the market down sharply.


So getting back to the probabilities. I would break-it down like this.
1. Taper Continue, 40% = Market sees slight selling pressure.
2. Reduction of Taper, 50% = Market rallies but may hit resistance.
3. Halt Taper, 10% = Market rallies strongly.

Yellen Talks!

Words do matter because she will set the tone for the future monetary policy and how the Fed sees, interprets, and measures the economy. She will, of course, refer to headline data, U3 rate, and CPI, which is the Fed’s measuring sticks, while certainly not the best ones. No doubt that every member of the FOMC is smart and certainly reviews the data in detail, beyond the headlines and window dressing; however, they will not mention anything beyond headlines. If they did it would delegitimize the value of those headline window dressing numbers. Remember part of the Fed game, much like politicians, is creating perception.

Courtesy of ibankcoin

Yellen needs to craft a message that will talk about the GOOD in the economy, but also mention some struggles and stagnation. She will most likely remind us about the success of the QE policy and that the government needs to continue to stimulate longer to help jobs.

As I mentioned before, Yellen is far more dovish than Bernanke, but she is also far more Socialist as well. She believes that the Fed has a LARGER role to play in both jobs as well as banking. Her papers have talked about government wage subsidies, which is as Socialist as you can get. She has a similar political vein as Senator Elizabeth Warren, whom wishes to turn the Post Office into a bank for pay-day loans and low interest rate loans for the poor and lower middle class. I have a sneaking feeling that over time we will see a more politically socialist Federal Reserve that wishes to expand their role and policies. Our Fed could very well move beyond the squabbles between economic theory and into the realm of direct political intervention and legislation.

Yet, this will be her first meeting so I think she will be cautious and test the waters. She needs to know what kind of feedback and push back she will get from her Hawks, the market, and the economy as a whole. She doesn’t want to rock the boat and I certainly don’t think she will take an initial aggressive stance, but I feel if she takes baby steps it might embolden her to take more action. We saw Senator Warren’s small steps, testing the water and as the people and associates have absorbed her quiet message, she has become ever more emboldened, vocal, and I would say radical. I think Yellen will be far more calm, but ever diligent in pushing forward her agenda and ideological view. It could just sneak-up without us noticing.

Support & Resistance

INDU 16,250
We closed above it, but I suspect we could see some resistance at 16,400. Today the market will react to Yellen and the monetary policy.

NDX 3650
We could rocket to 3750 pretty quickly. Today is not about technology or company news, it is all about the FOMC meeting, Taper, QE, and Yellen.

SPX 1860
I would look at 1860 as a short-term support. Odds are that Yellen will be accommodating. We could see a spike to 1880. The VIX is down in the 14 level.

RUT 1200
The RUT is above 1200 and Yellen could turn 1200 in to a new support level, depending how accommodating she is.

Future Inflation?

For the market to not see any big knee-jerks or new trends, Yellen would have to stay the course and continue Bernanke’s legacy. Sure, her words could craft some additional volatility into the market, but ultimately it will come down to Monetary Policy, interest rates (which are staying the same), and what does she do with the current Taper policy.

The market is ready and poised to go higher. Whether we agree or not with their economic views is of little consequence. We can’t fight the Fed and we shouldn’t try; however, we should be cautious because government intervention can only go on for so long before the legs weaken and inflation becomes a real risk.

Little do we remember the 1970′s when coming off the gold standard and a massive government inflationary policy sent inflation rocketing into double digits. The Fed took the very unpopular stance in raising interest rates to 20% to try to make the dollar more attractive to stop the flight from dollar based assets and reel in inflation, which was weeks if not days away from becoming hyperinflation.

Back at the beginning of QE, Warren Buffet predicted we could see inflation as high as it was in the 1970′s. Those words are from a few years ago. Nothing has happened with all the government printing, so it’s ok to print more, right?

One Response to “Ultra Dovish Fed”

  1. Good article about the Fed ramping up QE in through the back-door. The unofficial policy.