"But an inferior talent can only be graceful when it's carrying inferior ideas. And the more narrowly you can look at a thing the more entertaining you can be about it."
-- F. Scott Fitzgerald
Are You Not Entertained?
The midday financial television programs illustrated some kind of scenario on Wednesday afternoon where if the Federal Reserve did anything at all, beyond whistling past the graveyard with their eyes closed, that there would be some grand surprise. Then, as all sentient beings who write on these matters had predicted (making none of us special), there was minimal change made to the official statement, the economic projections including the dot plot evolved rapidly, and there was at least some effort to address overnight markets for excess cash.
What we (this is really just me) got wrong, and this was more of a wish than a projection, was that maybe the Fed could start tapering without impacting the broader economy -- by starting to remove purchases of mortgage-backed securities as it has been some time since that market has needed support. Instead, the massive and rapid drumbeat of money creation will continue at a truly incredible, and only acceptable in a crisis pace of $120 billion per month.
The media called the Fed "hawkish."
I see it as "late."
The statement was for the most part copied and pasted from April, the only change an acknowledgement that progress on COVID-19 vaccination has acted as an economic stimulant. Important carryovers were that the FOMC still sees inflation as transitory, and that the dual mission at hand (its mandate) remains unchanged -- maximum employment and an inflation rate of 2% over the longer run. In addition, the central bank reaffirmed the current pace at which it will fund the federal government while also propping up the already mentioned market for mortgage-backed assets.
The real action, as all sentient creatures expected, was in the group's economic projections. The median expectation for 2021 growth in GDP moved up to 7% from 6.5% in March, and then still tailing off beyond the current year. The range of expectations moved higher and narrowed from 5%-7.3% to 6.3%-7.8%.
Median expectation for 2021 headline level inflation moved from 2.4% in March to 3.4%, and of course also tails off after that. The range of expectations there moved from 2.1%-2.6% to 3%-3.9%.
As for the fed funds rate, the median expectation is still for 0.1% this year and next year, but moved from 0.1% in 2023 to 0.6%. Maybe we should all run around like screaming banshees, for the sky is indeed falling if the Fed thinks that it may have moved toward normalizing policy by the year after next. Maybe, just maybe... you band of fools (not you the reader, but the clowns on parade also known as talking heads with no skin in the game) need to be cognizant of the fact that if the Fed cannot project policy adjustment over a long-term window then that sky will indeed have already fallen. Gee whiz.
1) The change in the FOMC's projections in just three months' time tell us one thing... that those sitting on the committee just do not know any more than do the rest of us.
2) Those of us who live in this world have known this fact forever.
3) Just get rid of the dot plot, Jay. Makes your job harder. You can even still make economic projections if you like, but it should include a parallel control group of lay people, and a third group comprised of monkeys throwing darts at a dartboard -- just so the public can see that there is no crystal ball involved.
Not What I Meant
While I do appreciate the Fed doing something to address the nightly cash stash of homeless, orphaned reserves, simply carrying on with the excessive growth in money supply and the monetary base while tweaking a couple of short-term interest rates was not what I was going for. But it is something.
Were I leading this Fed, the monthly purchase of assets would have been reduced to $80 billion per month not on Wednesday, but very early this year. You all know that. It is one thing to feel compelled to fund the federal government at artificially reduced cost during a crisis, and another thing completely to create excess liquidity that supports a market not in need of support that ultimately constricts the ability of younger and less wealthy citizens to access hard assets (real estate), or to form their own households.
What the Fed did do, and this is in a sense, a tightening of policy, was to make two "technical" rate hikes. "Technical" makes them sound less scary. The Fed increased its overnight reverse repurchase agreement facility from 0% to 0.05%, and the interest paid on excess reserves from 0.1% to 0.15%.
Why would they do this?
Simple, and that's the scary part. With all of this excess cash looking for a home on a nightly basis, and ever more cash on the way, the possibility of negative short-term interest rates, which is something I believe nobody wants at least not right now, would be a reality should that nightly cash dump simply grow. If these two rates go negative, what's to stop the effective fed funds rate (not the target which is still 0% to 0.25%) from doing so? The effective fed funds rate has been stuck below 0.1%, closer to 0.06% for some time.
What will happen, and maybe this is something the Fed is counting on, will be that banks will in effect, trade these reserves daily not for profit, but to find them a home. What does that mean for markets? I think it could mean pressured yields on U.S. 30-day and 90-day paper. Maybe even longer-term paper, but that introduces more volatility, which is not welcome in this scenario. Not that the banks would hold anything for very long, but that they would by necessity, through the use of their excess reserves, be nearly permanent players in those markets, or at least to a greater degree than they already are.
Timing
The FOMC has three policy meetings left in 2021 that really matter (discounting next month): September, November, and December. Should there be no surprises (which is unrealistic as I expect economic growth to moderate over the second half of the year and I am not sure it understands this), then grand plans for a slow withdrawal of accommodation are laid down at Jackson Hole in late August. These plans make their way into the September statement, and by either November or December actual tapering of asset purchases becomes policy.
I want you kids to understand what I am about to say. Should the tapering run easily, it will take between a year and two years to get from $120 billion in monthly purchases down to zero, and the Fed will want to end tapering before increasing the target for the fed funds rate. This is going to happen while economic growth, as well as inflation likely fade well past peak. What that means is that the Fed will be tightening policy while the economy struggles -- all while the legislature tries to go back to the well of fiscal stimulus. You see where I'm going with this? There is no neat and tidy exit strategy.
Stagflation -- inflation without much economic growth -- is a very real threat. I know some of you were around the last time stagflation was a big deal. Remember how awful that was? Remember Mom and Dad eating less and hoping us kids didn't notice? This time we're not going to do it with a debt-to-GDP ratio in the 30%'s just as an FYI.
Am I predicting "The End of Days"? No. What I am predicting though is a prolonged era of difficulty. Across the nation. Across all nations. Blame it all on the pandemic if you like, but it was recklessness in policy implementation over decades and especially in those latter post-financial crisis/pre-pandemic crisis years (say 2012 through 2019) that led us here.
London Bridge Is Falling Down
Build it up with wood and clay
Wood and clay, wood and clay,
Build it up with wood and clay
My fair lady.
Wood and clay will wash away
Wash away, wash away
Wood and clay will wash away
My fair lady.
-- from the "Pretty Song Book" by Tommy Thumb (1744)
Economics (All Times Eastern)
08:30 - Initial Jobless Claims (Weekly): Expecting 362K, Last 376K.
08:30 - Continuing Claims (Weekly): Last 3.499M.
08:55 - Philadelphia Fed Manufacturing Index (June): Last 3.9% y/y.
10:00 - CB Leading Indicators (May): Expecting 1.3% m/m, Last 1.6% m/m.
10:30 - Natural Gas Inventories (Weekly): Last +98B cf.
The Fed (All Times Eastern)
No scheduled public appearances.
Today's Earnings Highlights (Consensus EPS Expectations)
Before the Open: (JBL) (1.04), (KR) (0.98)
After the Close: (ADBE) (2.82)
