The Fed decided to keep its interest rates unchanged at 1.5%-1.75% as it deliberated over its December FOMC meeting yesterday. The committee announced that they were comfortable with monetary policy where it was currently and will continue to monitor the developments as they unfold.
The statement was consistent with past messages, almost to the point of being scripted on repeat until further notice. But looking at the dot plot for the future, it suggested no rate increase or decrease for all of 2020. The median expectations for the Fed funds rate is 1.6% for 2019 and 2020, down from 1.9%, and rising to 1.9% in 2021, down from 2.1%. This is more dovish than expected as expectations were for at least one rate hike next year. Those hopes have now been squashed.
The elephant in the room, or lack thereof, is inflation. To the detriment of the committee, inflation expectations were reduced again this year. They see core personal consumption growing at 1.6% this year vs earlier expectations of 1.9%. No matter what the Fed does, it is lost as to why it keeps missing its inflation target -- tormented with flashbacks of Japanification with every print. The Fed has already cut interest rates three times this year and yet they keep missing their target. Instead of trying to reassess the situation and perhaps try a different experiment, they have decided to do what they know best, keep printing and increasing their balance sheet, in effect inflating risky assets even further.
Of course, this was not brought up in the press conference nor was it asked about by any sensible member of the press. One wonders, if the economy is in "such good shape" with record low unemployment and wage growth, why has the Fed needed to pump billions of dollars in the repo market every day for the past three months and buy Treasury bills of $60 billion/month, increasing their balance sheet close to $306 billion? Such a great opportunity, and this one simple question was left to the imagination. What is the use of a press conference if all questions are scripted.
As the press is filled with pages and pages of repo crisis and overnight and term rates potentially shooting higher after the September 17 fiasco, Powell did nothing to explain what caused the spike in rates or a shortage in liquidity. The Fed is still examining the situation according to Powell, and will continue conducting a series of operations to keep liquidity flowing to make sure the Fed funds rate stays in range. Would it not be wiser to solve the problem than just shove it under the carpet?
Something is clearly broken in the system and the Fed knows it. They are just too scared to admit or verbalize it. The financial system since the Global Financial Crisis and all its pent-up debt cannot survive in a world of tight monetary policy, even in the least. The only way to keep going is to keep it even more accommodative, giving in to the tantrum of a child because the parents are too scared to handle the reaction. That is where we are at.
The Fed is so scared of deflation that its hurdle rate for dealing with inflation is a lot higher than the market perceives. They rather it be above 2% and higher sustainably and then raise rates. This has been a game changer in the past month and it continues to advocate for the Fed's supportive "lower for longer" loose monetary policy regime.
Inflation will be a big theme for 2020 and the asset class to benefit the most will be commodities -- namely ones with very tight fundamentals like copper and then iron-ore. Oil will benefit in the short term with this pick up, as seasonally we are in a favourable time when demand does tick up, especially as the OPEC+ alliance is bent on taking even more barrels out of the market. They have an incentive, not only do they need $85/bbl Brent to balance their budget spending plans, but also they have to save face and show how successful the Aramco IPO has been.
The energy and mining sectors have been laggards this year on the back of the global economic slowdown and falling commodity prices. Copper has been range bound despite the direst of economic data. Can you imagine where it would trade if growth showed even a hint of a pick up along with inflation?
A basket of large-cap copper companies with the highest production growth rates and lowest quartile cost of production will perform the best, with names such as Antofagasta $ (ANFGF) , Kaz Minerals $ (KZMYY) , Freeport $ (FCX) , Southern Copper $ (SCCO) and even the majors like Rio Tinto $ (RIO) and BHP Billiton $ (BHP) faring the best. Barring any negative rhetoric on December 15 when new tariffs are meant to be rolled back, copper is set to go even higher over the medium term.
