Thursday, October 5, 2017

This Week's Message: The Fed's Timing is Critical and Let's Pray Not Political!

As we've been reporting herein, the economic backdrop suggests a looming recession is simply not presently... well... looming. Quite the opposite in fact.

Here's this Monday's assessment of the existing trends* in what we view to be telling data points:

*Note: As you might imagine, some of the above indicators can be very noisy on a week-to-week basis. Which is why identifying the underlying trend is essential to properly gauging their message.

By the way, go here and here, if you're interested in how the above looked heading into previous rough patches.

Now, I must say, while the above doesn't scream inflation, the sheer optimism expressed by the color coding, let's say, yells to the Fed to take this opportunity to clean up its balance sheet and to nudge rates higher. For, without question, you and I will live to see all of those green highlights fade to yellow then red as the present cycle wears itself out. And, alas, if that were to begin happening soon, the Fed -- the perceived savior of the world's largest economy -- having spent much of its fuel supply, would find itself in quite the compromised state.

Ah, but therein lies the conundrum for the present administration. Janet Yellen's term is up next February. While one might expect that under present circumstances she'd garner reappointment in the most unobstructed fashion, recent history has us expecting the unexpected. And, clearly, the news of late suggests that Ms. Yellen's tenure as Fed chair may indeed be nearing its end.

Here's a headline from last Thursday:

As it turns out, and interestingly (given that he's considered a frontrunner), Mr. Warsh is reputed to be a monetary policy hawk. Which means he's ultimately concerned with rising inflation and favors raising interest rates sooner than later. My best guess is that the above headline is, therefore, jumping the gun. While political candidates make great sport of all of the Fed's economic stimulus during their opponent's reign, oh how they change their tunes once in office. Show me a sitting politician who desires reelection and I'll show you someone who wants the Fed to keep rates low and money flowing till the cows come home -- or till he or she is ready to leave office -- regardless of the long-term risks.

Take a look at interest rates during the two days following the Warsh headlines:

Nope, I don't think it'll be Mr. Warsh. Unless that is he can convince the Administration that his rep is undeserved and he can be as dovish as any economist angling for a legacy -- and a monster book deal.

Looks like there's a more convincing candidate in the mix; the presumed dovish Jerome Powell. Here's the headline:

And here's the immediate reaction in the interest rate markets:

Now you're talking! 

I'm being facetious by the way: In the longer-term scheme of things, pragmatism is what the Fed needs. Whether that would be best displayed at the hands of hawkish Warsh or continuing on with moderate Yellen, trust me, what we absolutely don't need is a politically-captured Fed chair who would do the bidding of sitting politicians. We had that under Nixon
Evidence from the Nixon tapes, now available to researchers, shows that President Richard Nixon pressured the chairman of the Federal Reserve, Arthur Burns, to engage in expansionary monetary policies in the run-up to the 1972 election. This paper quotes the relevant conversations from the Nixon tapes. Questions remain as to whether Burns followed an expansionary policy in an already-inflationary environment out of conviction or because of political pressure.
and it didn't turn out so well:     emphasis mine...
When 1972 came around, unemployment had continued to rise, with 2 million more Americans out of jobs than in 1969. The administration decided it was time to stimulate the economy with a $25.2 billion budget. In the election year, the money supply was expanded by 9 percent. This caused many to accuse Nixon and Burns of making a deal so that Nixon could win the upcoming election and Burns to keep his government position. Both men denied the accusation.
Soon in the fall, the economy began to improve. Unemployment was finally dropping and inflation was staying relatively in control. America had temporarily gotten out of the recession. Unfortunately inflation soon increased after the election. When the failed wage and price controls were lifted, other problems took their toll on the American economy. An expanded money supply, the effects of increased deficits and the rising price of oil all left their mark on the American economy. By 1973 inflation increased 8.8 percent, then 12.2 percent in the following year.

What makes this go round markedly different than the Nixon Era is that -- per our analysis -- the economy is presently doing fine. As we stated above, it's time for the Fed to begin deflating its balance sheet, replenishing its fuel, while keeping inflation at bay in the process. 

We'll keep you posted...

Have a great weekend!

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