And So Begins The Rug-Yank Phase Of Fed Policy

Authored by MN Gordon via EconomicPrism.com,

The political differences of today’s leading two parties are not over ultimate questions of principles.  Rather, they’re over opposing answers to the question of how a goal can be achieved with the least sacrifice.  For lawmakers, the goal is to promise the populace something for nothing while pretending to make good on it.

Take the latest tax bill, for instance.  The GOP wants to tax less and spend more.  The Democrat party wants to tax more and spend even more.  We don’t recall seeing any proposals to tax less, spend less, and shrink the size of the state.  And why would we?

Today’s central planners and social engineers are enlightened and progressive.  They know much more about anything and everything than the rest of us.  In particular, they share a general sense that they know how to spend your money better than you.

At best, the central planners call your money to Washington so they can then distribute it back to your friends and neighbors.  In reality, the lawmakers call your money to Washington where they distribute it to their friends and neighbors – not yours.  This is not a matter of opinion.  It’s a matter of fact.

Is it a coincidence that the top three wealthiest counties in the country are in the shadow of the Capitol in the D.C. suburbs?  What it is exactly that the residents of these counties do that’s of tangible value is unclear.  However, what is clear is that bogus government jobs in Loudoun County and Fairfax County, Virginia, pay big bucks.  But that’s not all…

Garbage In Garbage Out

Further up the eastern seaboard, Wall Street has a good thing going too.  The big bankers and brokers make big bucks extracting capital from Main Street America.  That’s a fair characterization, right?

Perhaps the big bankers and brokers really are efficiently allocating capital to its highest and best use.  Who knows?  But as far as we can tell, they’re gambling with other people’s money – and collecting fees regardless of how their coin tosses fall.  It’s always, ‘heads I win, tails you lose.’  Not a bad fugazi gig, if you can get it.

Of course, the cornerstone of it all is the Federal Reserve.  Through what they call “open market operations,” the Fed rigs the game in Washington’s and Wall Street’s favor.  Indeed, the process is really quite elegant.

Under the smokescreen cover of garbage in economic data, the Fed’s economists produce garbage out bar charts and line graphs.  These, in short, are fabricated depictions of the economy’s growth, consumer and producer prices, personal consumption expenditures, unemployment rate, and whatever other aggregate metrics are deemed to be of vital importance.  What’s more, these fabricated depictions serve as the basis for the Fed’s monetary policy decisions.

Do the graphs show price inflation heating up or cooling down?  What about GDP or the unemployment rate?  Is one going up while the other’s going down?  Is one going down while the other’s going up?

The Federal Open Market Committee (FOMC) deliberates over these questions about every six weeks.  Then the Fed goes to work inflating the nation’s money supply, with the occasional rug yank, for the stated purpose of getting the charts and graphs to illustrate the garbage data to their liking.  What to make of it?

The Rug Yank Phase of Fed Policy

From the outside, the Fed’s economists and planners appear to be esteemed professionals, making decisions with the intent of providing for the greater good of the country.  They even attend economic conferences and forums where they present their latest research findings on abstract topics like liquidity traps.  Some of their studies even include footnotes, as if the professional economists are building upon a concrete knowledge base of human intellect.

Yet beneath this cover of bogus science, the real sausage is made.  Capital is borrowed into existence where it is directed to Washington and Wall Street.  There, having first dibs on this phony money, Washington and Wall Street get to spend it as if it has real value.

However, the real value does not coming from the Fed’s phony money.  In fact, as this new phony money appears on the scene, it extracts incremental wealth from the workers and producers across the country that – through their time, talent, and labor – created the wealth to begin with.

At the moment, we’re in the rug yank phase of the Fed’s monetary policy.  This is where they reel back credit ever so slightly after letting it run wild over the last decade.  This tightening of credit markets has the effect of pulling the rug out from under financial markets and the economy.

Monetary policy, without question, is not an exact science.  It’s rudimentary guess work that’s based on committee interpretations of bogus data.  This week, the FOMC raised the federal funds rate by 0.25 percent to between 1.25 and 1.5 percent.  This marks the third increase this year and the fifth increase this cycle.

Incidentally, Janet Yellen also delivered her last press conference as Chair of the Federal Reserve, though she’ll likely still Chair the FOMC meeting scheduled for late January.  Then Jay “Count Dracula” Powell will take over the helm of the nation’s central bank.  The broad expectation is for Powell to continue the rate increase playbook that Yellen has laid out, which includes three quarter percent hikes in 2018.

We wish Powell the best in his endeavors.  But we suspect he’ll unwittingly pull the rug out from under financial markets and the economy before he completes his first year.  After that, the fun really begins.

The Fed is Arranging Deck Chairs on the Titanic (the Iceberg Comes in 2018).

The Fed concludes its final FOMC meeting of the year today.

The entire financial world expects the Fed to raise rates a final time. This will mark the fifth rate hike since December 2015, and the fourth of the last 12 months.

Throughout this time period, the Fed has routinely stated that it is confused as to why inflation is “too low.”

Inflation is not too low. The method the Fed uses to measure inflation is intentionally incorrect. As a result, the official inflation numbers reflect whatever the Fed wants, as opposed to reality.

Alan Greenspan devised this entire gimmick back in the 1990s. At that point, the amount of debt in the US financial had already become a systemic issue.

So Greenspan opted to “paper over” this fact via inflation… hoping that by aggressively devaluing the US Dollar he could keep this game going.

The only problem as far as the Fed was concerned was that the inflation numbers would reveal the Fed’s strategy. So Greenspan started tinkering with how the Fed measured inflation, removing various components (food and energy) and tweaking things so the Fed would no longer measure the cost of maintaining the same quality of life.

Greenspan hoped understating inflation publicly he would give him the cover he needed to pursue an aggressive devaluation of the US Dollar. The flip side of this was that the Fed would begin intentionally creating asset bubbles by maintaining loose monetary policy ad infinitum.

The late ‘90s was the Tech Bubble.

When that burst in the mid-‘00s, the Fed created a bubble in housing.

When that burst in ’08 the Fed created a bubble in US sovereign bonds or Treasuries.

And because these bonds are the bedrock of the US financial system, the “risk-free rate” of return against which ALL risk assets are valued, when the Fed did this it created a bubble in EVERYTHING.

That bubble is now beginning to burst. And ironically it is inflation (which the Fed claims is too low) that will do it.

It will take time for this to unfold, but as I recently told clients, we"re currently in "late 2007" for the coming crisis.

The time to prepare for this is NOW before the carnage hits.

On that note, we are putting together an Executive Summary outlining all of these issues as well as what’s to come when The Everything Bubble bursts.

It will be available exclusively to our clients. If you’d like to have a copy delivered to your inbox when it’s completed, you can join the wait-list here:

https://phoenixcapitalmarketing.com/TEB.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

Meanwhile... The Yield Curve Is Crashing-er

Remember Monday when stocks jumped and the yield curve steepened and every talking head and their pet rabbit said the bond market is about to explode... well the yield curve is now imploding again with 5s30s crashing almost 10bps to 64bps - the lowest since Oct 2007.

False start...

 

The trend is jnot The Fed"s friend...

 

This morning Fed"s Bullard warned that more rate-hikes could invert the yield curve (which has signal 7 of the last 7 recessions).

“There is a material risk of yield curve inversion over the forecast horizon if the FOMC continues on its present course of increases in the policy rate," Bullard, who doesn’t vote on the policy-setting Federal Open Market Committee until 2019, said on Friday in Arkansas.

 

“Yield curve inversion is a naturally bearish signal for the economy. This deserves market and policy maker attention.’’

Hoever, last night Cleveland Fed President Loretta Mester on Thursday played down concerns about the yield curve, instead advocating continued gradual increases in the federal funds rate.

“Long rates are going to go up given where we are in the economy and given where we see the economy going,” she said in an interview.

 

“But this is another reason why we need to keep raising up the short rate. These financial conditions are accommodative.”

So Bullard rightly worried, Mester - it"s different this time.

"One Simple Reason The Yield Curve Is Collapsing"

The divergence between the "hope" melt-up in stock markets and the "nope" collapse of the US Treasury yield curve has never been so wide... and has never engendered so many excuses by commission-takers and asset-gatherers for why the latter is wrong and the former correct.

One thing is clear, as The Fed tightens rates, the market is increaingly insensitive to the next tightening as financial conditions have eased dramatically as the Fed tightens. Former fund manager Richard Breslow suspects "you ain"t seen nothing yet" as the linkage between FOMC raising rates and a flattening yield curve suggests this tradable trend is far from over.

Via Bloomberg,

The yield curve in the Treasury market has continued on its flattening way. Look at a one-year chart and it shows a relentless, if at times choppy, move from its widest at the beginning of the period to today’s new tight. Everyone seems to have their theories why and what it means, giving clear proof that great minds can differ. And even the bond market isn’t simply well-established science. One thing that they do agree upon is the obvious: it’s been a clear, tradable trend. But before we start waxing eloquent on the historic magnitude of the move, keep in mind, this tightening absolutely pales in comparison to several others of the last 25 years.

It’s perhaps been so confounding only because, for all the ink spent on it, it’s been relatively gentle and gradual compared to past episodes. And why should that be?  

 

Perhaps because the FOMC has been raising rates at such a slow, methodical pace. And even then, investors continue to doubt the dots, despite December being taken as a given.

 

[ZH: As we noted previously, financial conditions did not snap tighter until The Fed has tightened rates to 5.25% in 2007]

 

Yield-curve moves have been intimately linked to FOMC policy direction and the speed of change. So, consider what might happen should the market come around to the Fed’s forecasts. Or the other way around. But don’t think the spread is necessarily anywhere near some impregnable floor.

 

 

 

And, most certainly, avoid falling for the notion that all by itself it will tell you where the economy is headed. That’s only the case if you believe the Fed always ends up over-doing it. Which may indeed explain the Greenspan era and why bond traders loved him so much--once everyone was able to put the 1994 spat behind them and he worked so hard to make it up to them.

 

All of this raises another angle to ponder. The Fed continues to enjoy a tremendous free-ridership advantage of tightening while the ECB and BOJ keep pumping in liquidity. Investors are forced to keep buying Treasuries on any back-up, and if not gagging on the prices, certainly retching every time there’s a lecture about complacency. Governor Kuroda has been emphatic that Japan must motor on pumping in liquidity with inflation continuing so low. President Draghi was able to fend off those who wanted a “clear exit” from asset purchases.

 

Many doubt, however, this forward guidance will hold. It’s not as if QE is exactly popular any more. And if economic slack continues to disappear any hint of inflation will be met by two competing responses.

 

Calls to let prices overshoot and be patient. And markets rushing to price in policy shifts from these two banks. That’s when all the back-slapping about how well it’s all going gets tested. It’s unclear whether this “all clear” sign for the rest of the world will let the Fed loose or make them rein in their ambitions.

The only thing we can be reasonably sure of, Breslow concludes, is the Fed realizes that whatever happens they need to make hay while the sun shines and history argues that is a curve flattener.

Dear Janet - About That Balance Sheet Normalization?

At the last FOMC meeting - on September 20th - Janet Yellen and her merry band of failed forecasters proclaimed that the Federal Reserve Balance Sheet would be allowed to normalize with reinvestments slowed or stopped in October.

There"s just one thing...

The Federal Reserve balance sheet has risen by over $5 billion in October - the biggest monthly rise since February.

 

Now, we are well aware of the lags in reporting data from SOMA but this is as of last Wednesday and so unless The Fed suddenly dumped over $5 billion in its balance sheet on Thursday and Friday, we suspect "normalization" means something different to the PhDs at The Fed than it does to the avereage joe.

Don"t Fight the Fed

Alexander Hamilton, George Washington’s Treasury Secretary, in his first “Report on the Public Credit” in 1790,

put forth the concepts of “assumption” and “redemption.”

He argued that the federal government should assume the Revolutionary War debt

and pay those debts at “face value” in full to the bearers of such debt on demand.

In order to redeem the $75 million of bonds, Hamilton promoted the creation of a “sinking fund”

that would pay off five percent of the bonds annually.

Revenue to pay off the principle and interest should come from tariffs on imported goods and an excise tax on whiskey.

Bondholders would be due 4% annual interest payments.

 

Today, the total value of US Treasury Bills, Notes, and Bonds is above $20 trillion

and rising. US Treasuries are the global standard of debt, as is the US Dollar the standard for currency.

A bond investor today would enthusiastically buy 4% US Treasuries, if he could buy them at “par value” or $1000 per bond.

Today’s10 Year Treasury Note Yield is 2.309%.

In today’s bond market, a 4% bond is worth $1150, according to the Hewlett-Packard 12C calculator, a $150 “premium.”

However, if a bond investor believes that market interest rates will rise over time, the price of that 4% bond should

fall until the market rate, now 2.309% matched or rose above the bond’s “coupon rate” of 4%.

The decision to buy, sell or hold US Treasuries takes into account the “interest rate risk” just described.

US Treasuries today carry the lowest “default risk” among global government bonds, so investors need only

consider interest rate risk. Bond prices determine not only what a bond investor will receive twice per year

in interest payments, but also what a borrower pays monthly to finance a home purchase or start a business.

That is where the rubber meets the road for the Fed’s influence on economic expansion or contraction.

The driver of the vehicle to which those wheels are attached is the Federal Open Market Committee (FOMC).

It directs the market operations of the Federal Reserve System (The Fed).  

Fed action affects the price, and thus the yield, of US Treasuries by buying and selling in the open market.

When the Fed buys, it decreases the supply, increases prices, and lowers the yield. Selling increases supply, decreases prices, and raises the yield.

The Fed also sets theFed Funds Rate, the interest rate at which banks may lend money to each other

on an overnight basis.The rate at which banks can borrow also influences the rate at which they will lend to their customers

via home mortgage and business loans. The higher the Fed Funds Rate, the higher the interest rates on loans.

Most often, the effective Federal Funds Rate is lower than the yield on US Treasuries,but not always.

If the Fed wants to slow the economy, it will raise the Fed Funds Rate and make it more expensive for banks to borrow.

Paul Volker’s Fed, in June of 1981, raised the Fed Funds Rate to a peak of 20% in order to squelch the rampant inflation of the 1970’s. He succeeded. His Fed’s action was accompanied by the 1980-82 recession and its 10+% unemployment rate.

If the Fed wants to encourage lending by banks, it can lower the Fed Funds rate.

If banks can borrow at a lower rate, their loans to homebuyers become more profitable, and they will tend to lend more,

but not always. During the 1990-91 recession, which followed theSavings and Loan Crisis of the late 1980’s

and the invasion of Kuwait by Iraq, Alan Greenspan’s Fed dropped the Fed Funds Rate from 9.75% in December of 1988 to 3.0% in September of 1992. Greenspan stated his frustration with the stubborn 7+% unemployment rate and banks’ unwillingness to lend by saying, “You can’t push on a string.”

Paul Volker’s Fed proved that rising interest rates will eventually slow the economy and stem inflation,

but his successors—Alan Greenspan, Ben Bernanke and Janet Yellen—did not meet with equivalent success by lowering rates to stimulate the economy and reduce unemployment.

It turns out that bankers will not lend unless they see a potential for profit.

Loans to poor credit risks can end up as losses on the balance sheet and unemployment for loan officers.

Bankers want to make money, but they also want to keep their jobs.

 

Confronted with what would later be known as “The Great Recession,” Ben Bernanke’s Fed dropped

the Fed Funds rate from 5.25% in June of 2006 to 0.25% in December of 2008.

Even though banks were able to borrow at an effective 0% interest rate, unemployment continued to rise.

The unemployment rate was 10.0% in October of 2009 and did not drop below 9% until October of 2011.

The Organization for Economic Co-operation and Development considers full employment to be an unemployment rate of between 4% and 6.4%.

 

For Ben Bernanke, author of Essays on The Great Depression, the worst economic event in US history was not the inflation of the 1970’s, but the deflation of the 1930’s. When, in 2008, a zero-percent Fed Funds rate had little effect on the unemployment rate,

Bernanke’s Fed began buying bank debt, mortgage-backed securities, and treasury notes.

The intent of this “quantitative easing” was to flood the banks with liquidity in order to bring down long-term interest rates.

By the end of his second term, the Federal Reserve had transferred $4.5 trillion to the US Treasury from bank balance sheets. When Bernanke’s second term as Fed Chair ended in 2014, unemployment was still at an unacceptable rate 6.7%.

Janet Yellen, the first female Chair of the Federal Reserve, defended quantitative easing,

but vowed to revert to traditional monetary policywhen economic growth and unemployment returned an acceptable l

evel. Her Fed targets a 2% growth rate forGross Domestic Product (GDP) and is now close to achieving that goal.

The US economy expanded at an annualized rate of 3.1% in the second fiscal quarter of 2017.

Yellen’s Fed has increased the Fed Funds rate four times and projects continued gradual rate increases.

On Tuesday, September 27th,Ms. Yellen told the National Association for Business Economics, “It would be imprudent to keep monetary policy on hold until inflation is back to 2 percent.”

But she also admitted that the Fed’s understanding of inflation is “imperfect” and that the apparent lack of inflation in the current full-employment economy is “a mystery.”

She said, “We recognize that something more persistent may be responsible for the current undershooting.”

 

Happy Black Friday

Amsterdam | As the financial world happily fixates on who will be the next Fed Chairman, I am in Europe celebrating the 30th anniversary of Black Friday, October 19, 1987. Three decades ago, I was on a trading desk at Bear, Stearns & Co in London along with David, Joey, Gregory, Peter and Paul, among others. We had just finished a remarkable four year run, but the party was over.

That fateful day, our Treasury/MBS trader Matt got his eyes ripped out early in the day. His big mistake was answering the phone. Investors lifted every offer for US Treasury paper to be found. We were short a couple of bucks before 10 AM with no offers to be found. We stopped answering the phone way before lunch. Fortunately, we had large sell orders from several Japanese insurance companies so by the close Matt was flat and went home to have a couple of well-deserved pints.

This story is relevant today because the markets seem to have forgotten how it feels to be physically molested without the protection of Mother Fed. As I told Frank W. from Handelsblatt earlier today, the crash in 1987 was the last financial crisis where the private markets were allowed to function without government support. We had manipulated markets when I worked at the Fed of New York, but only on the margins.

Since 1987, however, the US government (i.e. the Federal Reserve) has turned market stability into an entitlement. The degree of government intervention in the markets has grown enormously since Black Friday 1987, with no authority or even acknowledgement from Congress, begging the question as to whether the United States can any longer be described as a free-market democracy.

Whether we admit it or not, the global markets are in the hands of a cadre of “experts” at the various central banks, who make decisions based upon private deliberations and questionable reasoning. The markets depend upon these experts to provide the expected stability, making the entire financial system more fragile today than ever before. Neither capital nor even market intervention by central banks is the issue here. The currency of financial stability is, more than ever before, confidence. And the people who are piloting the starship have not a clue what they are doing.

Case in point, the FRBNY is conducting “stress tests” on how the sale of mortgage backed securities will impact the markets. The tests are tiny, double digits millions of dollars. The fact that the Fed is even doing this illustrates not only the fragility of the financial markets, but the lack of understanding and familiarity that the FRBNY has with the markets it is supposed to surveil. With Treasury 2s to 10s at the narrowest spread ever, one has to wonder just what the Fed is waiting for in terms of portfolio sales. See chart below c/o Ed Harrison.  Fact is, the Fed is in a special trap of its own design. By continuing the process of QE (that’s “quantitative easing” in FedSpeak) beyond the first round in 2010, the central bank skewed the credit markets to an enormous degree and, in the process, boosted asset prices for everything from stocks to bonds to commercial real estate. The rally in stocks is all about cheap credit.

Naturally, the Fed cannot “normalize” interest rates (and credit spreads) unless it first sells a large chuck of the $3.8 trillion in securities on its book. But Janet Yellen & Co on the FOMC, know now that they have screwed up large by continuing with QE after 2010. Naturally they are reluctant to admit this error. Like the Church of Rome, the Fed is never wrong. And Yellen is afraid to put the proverbial magic bus into reverse for fear that both stock and bonds, which are now 100% correlated, will tank simultaneously. And they are right to be concerned.

Chair Yellen is wedded to a neo-Keynesian/socialist world view. Thus the FOMC has moved benchmark rates before selling any of the mortgage paper or Treasury bonds in the System Open Market portfolio. Anybody who understands the bond markets and duration will tell you that there is more that sufficient demand to soak up $50 to $100 billion in MBS per month in current market conditions, especially when you consider that agency MBS issuance will probably be down $400-500 billion in 2017 at $1.6 trillion vs $2 trillion in issuance last year.

Yet somehow our friends at the Fed can look at narrowing bond spreads and a completely manic stock market, and do nothing. Raising benchmark rates is pretty much an exercise in futility because there is no “cascade” from Fed Funds to longer maturities. Indeed, absent some pesky externalities, bond prices are likely to rise and yields will fall because of the intense demand for duration from end investors and other central banks, who continue to buy public and private debt.

Remember that with short-term "risk free" Treasury rates at current levels, the net-present value of equities is far higher than current market valuations. Yet by the time that President Donald Trump gets around to picking the next Fed Chair, the markets will be ready for a truly cathartic collapse, a “reset” if you will. The only thing that will delay the great repricing will be, naturally, a tax cut from Washington. Once that final act of idiocy has been achieved, however, there will be no more shiny objects to fascinate Wall Street.

Banks and interest rate investors will be starring at a flat yield curve – the traditional signal for an approaching recession – and there will be no real reason to keep playing at the big table. Indeed, the smarter players will be taking the money off the table before Congress actually votes on a tax cut. Fact is, most large cap stocks that are bobbing around at multi-year highs will tumble once the proverbial deed is done in Washington. Tesla anyone?

Once the stock market begins to crack, Yellen & Co will not only need to delay asset sales, but they will probably be bullied into mimicking the European Central Bank and the Bank of Japan, and start buying both bonds and stocks in the name of financial stability. For as we mentioned earlier, financial stability is now an entitlement, like defaulting on your home mortgage. So start practicing your Italian, make sure that you have plenty of ammo and food at home, and sit back to watch the spectacle unfold.

Happy Black Friday

One of the Two Most Powerful Fed Officials Just Issued an Inflation Decree

The Fed is no longer even trying to hide the fact that it WANTS inflation.

In the last month, the Fed has attempted to feign ignorance about the true nature of inflation. Fed Chair Janet Yellen even went so far as to claim the Fed doesn’t “fully understand” inflation during a Q&A session in September.

The Fed “understands” inflation just fine, it just chooses to feign ignorance so it can maintain a “gosh, we didn’t know!” attitude about the coming inflationary storm.

Enter Chicago Fed President Charles Evans.

Evans, along with NY Fed President William Dudley, is the real “power behind the throne” for the Federal Reserve. Like Dudley, Evans is in charge of a branch of the Fed that is associated with one of the major financial centers of the US. In other words, he is a Fed President with close ties to the financial firms that call the shots for the US financial system.

This allows Evans to speak more bluntly than most Fed President. And when he talks, you know he is doing so with the full backing of the Chicago financial elite.

With that in mind, consider Evans’ recent statement on inflation.

Fed"s Evans: An increase in U.S. inflation is a priority

Chicago Federal Reserve Bank President Charles Evans said on Friday that the U.S. central bank’s priority must be to get inflation back to its 2 percent target…

“The first order thing for policy right now is to get inflation up to our objective,” Evans said at a financial literacy event in Green Bay, Wisconsin.

            Source: Reuters

As we’ve already noted, the Fed is well aware that inflation is already well above its 2% target. But with the US financial system sporting some $60 trillion in debt total (including all sectors of the economy) the Fed has no choice but to keep "papering over" these debts. Small wonder then that even the Fed"s own "sticky inflation" measure has been rising steadily since 2010 and is already clocking in well over 2%.

Put simply, BIG INFLATION is the THE BIG MONEY trend today. And smart investors will use it to generate literal fortunes.

We just published a Special Investment Report concerning FIVE secret investments you can use to make inflation pay you as it rips through the financial system in the months ahead.

The report is titled Survive the Inflationary Storm. And it explains in very simply terms how to make inflation PAY YOU.

We are making just 100 copies available to the public.

To pick up yours, swing by:

https://www.phoenixcapitalmarketing.com/inflationstorm.html

Best Regards

Graham Summers

Chief Market Strategist

Phoenix Capital Research

The Key Things To Look For In Today's FOMC Minutes

Looking at today"s scheduled release of Minutes from the September FOMC meeting (which at least according to one trader will be the "start of the market changeover process"), RanSquawk reminds us that the Federal Open Market Committee stood pat at the meeting, as expected. The Committee also announced that it would begin to shrink the size of its balance sheet in October, as expected, with the process falling in line with a previously disclosed detailed plan. Additionally, the summary of economic projections saw the FOMC trim its "longer run" Federal Funds target rate expectations, while the nearer-term core PCE projections were also trimmed, and GDP estimates were raised.

With that in mind, here is what Wall Street expects from the minutes to be released at 2pm ET today, courtesy of RanSquawk.

RBC suggests that the “debate surrounding the drop back in core inflation this year was particularly lively. The bounce-back in CPI inflation appears to have convinced the centrists that the earlier weakness was partly due to transitory factors, whereas the doves are still worried about potential structural factors or lingering cyclical slack.”  This was reflected by the fact that 12 of 16 officials that submitted projections still anticipated at least one more rate hike this year.

In the press conference that followed the decision Fed Chair Janet Yellen noted that “low inflation this year, despite a substantial improvement in labour market conditions, created uncertainty for monetary policymakers.” Although she did note that low inflation may be “transitory” and as a result it does not negate the need for gradual policy tightening.

Since the decision, Fed rhetoric has increasingly cited structural headwinds for inflation, while some of the more dovish members have continued to highlight the need for a pickup in inflation before they are willing to vote for a hike (including 2017 voter Robert Kaplan, who was previously of a hawkish disposition).

Markets still lag the FOMC in terms of rate hike projections, pricing circa two 25bps hikes through the end of November 2018, will the median FOMC projection looks for four 25bps hikes through the end of 2018.

Focus has switched to the race to be the next FOMC Chair, with four notable frontrunners in contention at present (a primer is available here), with Barclays outlining their perceived monetary policy stances in the image below.

Deutsche Bank provided the handy crib sheet seen below, summarising what a victory for each respective front runner would mean across for Fed policy.

What The Bank Desks Are Saying: –

Barclays: Given the outcome of the September FOMC meeting, in which only four participants indicated no further rate hikes this year was appropriate, we expect the FOMC minutes to show that most participants see recent disinflation as largely driven by transitory factors. We expect the discussion to remain focused on inflation and its shortfall relative to what the Fed’s Phillips curve framework would suggest, but we believe most participants will view the unexplained weakness as dissipating over time, thereby permitting a return of inflation to the target. The minutes may indicate that members preferred to reduce their estimate of the longrun neutral rate of interest as opposed to halting the normalization process. Elsewhere, we expect the minutes to include discussion as to why it was time to begin balance sheet runoff and how members see the balance of risks to the outlook for the US economy.

Deutsche Bank: Inflation will likely be a heavily debated topic, but given the recent Fedspeak, it appears that most voting members are looking through some of the recent weakness and prefer to continue the “gradual” removal of monetary accommodation.

HSBC: The FOMC announced in September that it would initiate its balance sheet normalisation programme in October, as described in the June 2017 addendum to the committee’s “Policy Nomalization Principles and Plans”. The operational parameters of the programme had been communicated to financial markets in advance and did not come as a surprise. We will look through the September minutes to see if there was any further discussion regarding the expected impact of balance sheet disinvestment. Inflation was likely a major topic of discussion at the September FOMC meeting. In the conference following the meeting and in a subsequent speech, Fed Chair Janet Yellen noted that low inflation this year, despite a substantial improvement in labour market conditions, created uncertainty for monetary policymakers. In the end, the Chair concluded that low inflation may be “transitory” and that it had not persisted long enough to negate the need for gradual policy tightening. However, some other FOMC policymakers have indicated a preference for allowing inflation to pick up before raising policy interest rates any further. The FOMC minutes are likely to show a range of views on inflation, financial stability, and the implications for policy.

Morgan Stanley: The FOMC minutes are often revised nearly all the way up until the release and can be edited to stress important points. We look for the Fed to resume its gradual path of rate hikes again in December.

Watch Live: Hawkish Yellen Says Fed May Have Misjudged Inflation, Labor Market

Update: In her prepared remarks, Yellen crucially said,

“A more important issue from a policy standpoint is that some key assumptions underlying the baseline outlook could be wrong in ways that imply that inflation will remain low for longer than currently projected.”

As Bloomberg explains, she is stating a bit more clearly than before that the FOMC doesn’t have a handle on why inflation is low and acknowledging that it may last longer than they predict.

*  *  *

As we detailed earlier, on the heels of Bostic ("we didn"t blow any bubbles") Brainard ("some barriers to growth are structural") this morning and Kashkari ("no inflation"), Evans ("need more data"), and Dudley ("inflation"s coming soon") yesterday; it is Fed Chair Janet Yellen"s turn to speak this afternoon on "Inflation, Uncertainty and Monetary Policy" as the dollar extends its post-FOMC gains (to 1-month highs).

Since The FOMC, Fed Speakers have been active...

Raphael Bostic, Atlanta Fed president: "I actually don’t think that our policies are too easy in the sense of really facilitating some sort of asset bubble."

Lael Brainard, Fed governor: Benefits of a lengthy U.S. recovery “can only go so far” and some barriers appear to be structural, sees "widening gulf" between large, small cities.

Neel Kashkari, president Minneapolis, FOMC voter in 2017: “I don’t see inflation taking off so I see no need to tap the brakes.”

Charles Evans, president Chicago Fed, voting member: “I think we need to see clear signs of building wage and price pressures before taking the next step in removing accommodation.”

William Dudley, president New York Fed, permanent voter (and most notably considered to be closely aligned with Yellen"s way of thinking): “With a firmer import price trend and the fading of effects from a number of temporary, idiosyncratic factors, I expect inflation will rise and stabilize around the FOMC’s 2 percent objective over the medium term.”

As a reminder, the Fed Chair said that "we don"t fully understand inflation" and added that the "shortfall of inflation this year is more of a mystery," but, while Yellen speaking would normally be must-watch, with only a few days having passed since her post-statement press conference, we wonder just how much flip-flopping is possible. At that appearance, the Fed chief also downplayed the significance of the weak core inflation data as the central bank set the start date for the reduction of its balance sheet and signaled that an additional rate hike this year remained appropriate.

Additionally, though we doubt she will comment on it, Republican Senator Richard Shelby said he doesn’t think President Donald Trump will nominate Yellen for a second term at the helm of the U.S. central bank. Shelby said Tuesday in an interview with Bloomberg Television’s Vonnie Quinnthat he had spoken with the president about the Fed.

“I believe he will appoint somebody else to take her place,” the No. 2 Republican on the Senate Banking Committee said. “But ultimately, that is up to the president.”

Live Feed (from The National Association of Business Economics)

click image for link to Bloomberg"s Live Coverage

Headlines include (via Reuters)

• YELLEN SEES "CONSIDERABLE" ODDS THAT INFLATION WON"T STABILIZE AT 2-PCT OVER NEXT FEW YEARS


• FED"S YELLEN SAYS UNCERTAINTIES STRENGTHEN CASE FOR GRADUAL RATE HIKES


• YELLEN SAYS GRADUAL APPROACH TO RATE HIKES PARTICULARLY APPROPRIATE IN LIGHT OF SUBDUED INFLATION, LOW NEUTRAL RATE


• YELLEN SAYS THERE IS A RISK INFLATION EXPECTATIONS ARE NOT AS WELL-ANCHORED AS THEY APPEAR


• YELLEN SAYS DATA SUGGESTS LABOR MARKET IS HEALTHY, WITHOUT SUBSTANTIAL SLACK AND NOT OVERHEATED


• YELLEN SAYS EVIDENCE ON LABOR MARKET NOT DEFINITIVE, MUST BE "OPEN-MINDED"


• YELLEN SAYS WOULD BE IMPRUDENT TO LEAVE RATES ON HOLD UNTIL INFLATION REACHES 2 PCT


• YELLEN SAYS FED CAN STILL ACHIEVE 2-PCT INFLATION GOAL EVEN IF IT IS UNDERESTIMATING SLACK OR OVERESTIMATING INFLATION EXPECTATIONS


• FED"S YELLEN SAYS LOW INFLATION LIKELY DUE TO TRANSITORY FACTORS, SEES MANY UNCERTAINTIES


• YELLEN SAYS DOWNWARD PRESSURE ON INFLATION COULD PROVE UNEXPECTEDLY PERSISTENT


• YELLEN SAYS FED SHOULD BE `WARY OF MOVING TOO GRADUALLY"


• YELLEN SAYS WOULD BE IMPRUDENT TO LEAVE RATES ON HOLD UNTIL INFLATION REACHES 2 PCT

Via Bloomberg:

Fed Chair Janet Yellen said FOMC may have misjudged fundamental forces driving inflation and strength of labor market, and policy makers “stand ready to modify our views based on what we learn.”

• “We will need to stay alert” and adjust monetary policy as information comes in, Yellen said in text of speech Tuesday in Cleveland during annual meeting of National Association for Business Economics 


• “My colleagues and I must be ready to adjust our assessments of economic conditions and the outlook when new data warrant it”

Downward pressures on inflation “could prove to be unexpectedly persistent”

• Economic outlook is subject to “considerable uncertainty”

FOMC’s understanding of the forces driving inflation is “imperfect,” policy makers recognize “something more persistent” may be responsible for current undershooting of long-run objective

• While inflation will most likely stabilize around 2% over the next few years, “odds that it could turn out to be noticeably different are considerable”


• There’s also risk that inflation expectations “may not be as well anchored as they appear and perhaps are not consistent with our 2 percent goal”

Stabilizing inflation at around 2% “could prove to be more difficult than expected” 

Key assumptions underlying baseline outlook “could be wrong” in ways that imply inflation will remain low for longer than currently projected; for example, labor market conditions may not be as tight as they appear

Under certain conditions, “continuing to revise our assessments in response to incoming data would naturally result in a policy path that is somewhat easier than that now anticipated”

Significant uncertainties strengthen the case for gradual pace of tightening; however, Fed must also be wary of moving too gradually; “it would be imprudent to keep monetary policy on hold until inflation is back to 2 percent”

Actual value of long-run sustainable unemployment rate “could well be noticeably lower” than FOMC currently projects; can’t rule out possibility that some slack still remains in labor market

• Unemployment rate is probably “correct” in signaling that labor-market conditions have returned to pre-crisis levels; however, that doesn’t necessarily mean that economy is now at full employment


• Data suggest a generally healthy labor market, although can’t make “any definitive assessment”; policy makers “must remain open minded on this question” and its implications for reaching inflation goal 

The Markets Call "BS" on the Fed's Hawkishness

The Fed wants us to believe that it remains hawkish, that it will begin the process of unwinding its $4.5 trillion balance sheet next month and that it will hike rates again this year.

The markets aren’t buying it, even for a second.

The top performing asset class after the Fed concluded its announcement on Wednesday was… TREASURIES: the asset class that should DROP hard if the Fed intends to raise rates.

Apparently bonds didn’t believe that Fed Chair Janet Yellen was going to hike rates again for more than a few hours. As a result of this, the long-Treasuries ETF (TLT) actually OUTPERFORMED the S&P 500 as well as the NASDAQ post the FOMC.

Again, LONG-Treasuries beat Tech stocks after the Fed FOMC. The market doesn’t believe the Fed will be hiking rates again this year. Heck, the market doesn’t even believe that the Fed has a clue anymore.

As for the Fed’s proposal to unwind its balance sheet… does anyone remotely believe this will happen to any significant degree?

We know from Fed transcripts that Janet Yellen was worried about a balance sheet unwind as far back as 2009 when the Fed balance sheet was just $1.0 trillion. Somehow that same woman is now fully confident the Fed will be able to do this now that the balance sheet is the size of a G-7 country’s economy at $4.5 trillion?

Give us a break.

The reality is that the second the stock market begins to take a nosedive, the Fed will begin walking backs any talk of balance sheet normalization. Indeed, the only reason the Fed is even floating this idea is because stocks are at nosebleed levels. And with the Fed having failed miserably to generate economic growth, job creation or anything else, stock levels remain the one area of success to which the Fed can point.

Are they really going to jeopardize that, especially since Fed Chair Janet Yellen openly admitted the Fed considers “asset price levels” for its rate hikes (asset prices in Fed speak means stock levels)?

Nope.

The second stocks drop, the Fed will end its hawkishness. Indeed, judging by the looks of the $USD, the markets already know that the Fed will probably be talking about easing within 12 months time.

Put simply, the markets have called “BS” on the Fed this week. The one clear takeaway is that the Fed is no longer in control and that the markets smell “money printing” in the future.

This is going to be like rocket fuel for Gold and other inflation trades. Already the precious metal has broken out of a seven-year downtrend. And once the Fed stops walking back all talk of balance sheet reduction in the coming weeks, Gold is going to go THROUGH. THE. ROOF.

If you’re not taking steps to actively profit from this, it’s time to get a move on.

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Chief Market Strategist

Phoenix Capital Research

FX Traders Haven't Been This Worried About An FOMC Meeting Since Last Year

While equity implied vols are compressed to record lows - what could possibly go wrong with unwinding a $4 trillion balance sheet? - it appears FX traders are a little less sanguine about the market"s reaction to today"s FOMC decision.

And more specifically, one-day volatility in euro-dollar options surged to the highest level for the day of a Federal Reverse monetary-policy decision this year, suggesting elevated expectations among investors.

As Bloomberg notes, the raised level of the gauge suggests traders see a good chance of the euro breaking out of its recent range should Chair Janet Yellen surprise the markets on the outlook for Fed policy.

The probability of another U.S. interest-rate increase by year-end is over 50 percent, according to the overnight indexed swap curve.

Yet Another Theory Of The Fed (Or Why A "Major Policy Shift" Looms)

Authored by Daniel Nevins via FFWiley.com,

The world hardly needs another theory of the Fed, especially so soon after its Jackson Hole symposium. But we have a theory, too, and who knows, ours could be as close to the bulls-eye as any of the others. Plus, our theory is easy to explain - it rests on the simple premise that decision makers worry mostly about their reputations. We’ll propose that reputational risks are the primary drivers of central bank policies, and then we’ll use that belief to predict a major policy shift.

Why are reputations so important? Cynics might say they determine how much central bankers get paid once they leave the FOMC. Ben Bernanke, for example, wouldn’t collect $250,000 speaking fees and plush consulting contracts if he hadn’t bolstered his reputation during the Global Financial Crisis. And that’s not all—the crisis also lifted Bernanke’s power and importance beyond what it would have otherwise been. By landing in the Fed chair at an opportune time, he profited immensely.

But our theory doesn’t depend on that particular type of cynicism. We doubt that personal greed drives the Fed’s policy decisions. Whether they intend to cash their golden tickets or not (we’ll take the over on “intend to”), we view FOMC members as highly regarded folks who’d like to remain that way. They’ve reached a foothold at their profession’s highest mountain’s uppermost peak, from where the only direction is down. And remember—they didn’t arrive safely at their foothold by accident. If the president taps you for FOMC duty and sends you before Congress for approval, you’re already adept at protecting your reputation. You’ll probably do “whatever it takes” to steer clear of any reputational damage that could arise in the future.

When we talk about reputations, though, we’re not saying that a central banker’s legacy depends on whether her policies succeed or fail. Reputations are far more nuanced than that. Policies that fail can still preserve or even enhance the policymaker’s reputation, and vice-versa. What matters most is how the policymaker succeeds or fails.

Take Bernanke, again. During his first FOMC stint from 2002 to 2005, the committee responded to a deflation “scare” with successive rate cuts dropping the fed funds rate to a 45-year low of 1%. In just a few years time, people would see that boost to the credit markets as a mistake. And Bernanke was closely associated with it—he had long argued for fighting deflation with extreme measures. He then downplayed the risks of his preferred policies, as in his insistence that falling house prices were a “pretty unlikely possibility” and subprime mortgage troubles were unlikely to result in significant “spillovers.”

So Bernanke was a central figure in the lead-up to the crisis, but you already knew that. Our point is that it had little effect on his reputation. Among mainstream economists and in the mainstream media, he’s currently basking in the admiration of his “courage to act.” By comparison, his critics, mostly in the financial sector and outside the mainstream, point to his shortsightedness. Which perspective wins? As of today, the “hero tale” dominates. Just as presidents need only act presidential to gain plaudits during wartime, central bankers need only act aggressively to gain plaudits during financial crises. In either case, it doesn’t matter what came before.

Why the Fed’s Priorities are Changing

With those ideas in mind (that we’re dealing with perceptions more than realities), let’s look at the reputational risks faced by today’s FOMC. We’ll argue that the current decade’s primary risk - the risk of a 1937-style relapse into recession - is fading in importance. Until recently, an echo recession similar to the one that snuffed out the mid-1930s recovery would have been a reputation killer. It would have led people to question whether the 2008–9 recession would morph into another Great Depression, after all.

Even worse for the professional economists at the Fed, it would have lowered their status among the people who matter most to them—their peers. Consider that many economists (including Bernanke) blame the Great Depression on the Fed. Those economists would have surely piled on their policymaking contemporaries if the recent growth pattern had looked anything like the 1930s double dip. In any year from 2010 to 2016, a recession would have triggered a rethink of whether today’s monetary pooh-bahs are truly superior to those of the past.

As Dylan said, though, the times they are a changin’. The current expansion is now the third longest on record, as shown in the chart below. And if it continues through July 2019, it would become the longest on record. By that time, the Fed’s reputational armor would be as thick as ever.

It would be thick enough to deflect any attempts at equating current policies with the alleged 1930s blunders. Instead of the hit pieces that would have appeared after a recession in, say, 2015, pundits would pen bubbly narratives praising the superstars behind the longest-ever expansion.

But that’s not the whole story. We suggest asking the following: If the FOMC no longer fears an echo recession, what reputational risks remain?

Our answer is that the Fed’s reputation would tumble with any instance of severe financial turmoil. Imagine financial disorder slamming the economy once again, as in the 2008–9 crisis but taking a different form in the next iteration. In fact, many commentators warn that the Fed’s steady support for stocks and other risky assets could lead us into another mess. That may be a nonmainstream opinion and easily deflected, but only for as long as it remains just that—an opinion. If it proves prescient, it would flow into the mainstream. Regardless of the current expansion’s length, the FOMC’s reputation would be tarnished. (If you don’t believe us, just ask Alan Greenspan.)

Of course, we’re not saying anything that’s not already obvious, both outside and inside the Fed. That’s kind of the idea behind our theory—that the FOMC pays attention to its reputational calculus. Committee members may not discuss reputational worries for all to hear (few of us do), but those worries surely influence their policies. During the last few years, they worried mostly about an echo recession. By 2019, we expect them to worry mostly about the financial sector. And today, our theory suggests we’re in transition. We’re transitioning to policies that allow greater recession risks in order to reduce risks to financial stability. (Although a new Fed head might put the transition on pause for awhile if Janet Yellen isn’t reappointed next February.)

In other words, we agree with those Fed watchers saying the FOMC already shows greater sensitivity to financial risks. We expect further changes in policy priorities until, by 2019, avoiding a recession ceases to be a critical priority. And we expect those changes because we think FOMC members - perhaps even more than most people - care very much about their reputations.

Jackson Hole Preview: Market Reactions, And Why UBS Says "Don't Skip Lunch"

Historically the annual Jackson Hole symposium has been a major market-moving event as it has traditionally been the venue where central banks make critical announcements such as Bernanke"s preview and hints of QE2 and QE3 in 2012, as well as Draghi"s suggestion of the ECB"s QE in 2014. As shown in the chart below, market reactions following these events have been material.

This year, however, while there was a sharp build-up in expectations after several media trial balloons suggested that Draghi would unveil the ECB"s taper, the fact that the market sent the EUR just shy of 1.20 in frontrunning of this announcement, prompted the ECB head to abort the entire affair, "leaking" that no material announcement would be made this week in Wyoming after all. Which is why, in previewing potential market moves, Barclays says that "the risk for the EUR around the event is biased to the downside, and that EUR bulls might be disappointed by a lack of meaningful hints on ECB monetary policy normalisation."

ING is quick to take the fun out of this week"s annual meeting: "this year"s major speakers, Fed Chair Janet Yellen and the ECB President Mario Draghi, are likely to keep their cards close to their chest. Both speeches are likely to be fairly "high level" and lack any major hints about future policy."

As Deutsche Bank"s Jim Reid echoes, "there might be a few less nerves about the next few days in markets than many felt a few weeks ago. Back then, Thursday"s commencement of the annual Jackson Hole Symposium seemed to be a natural place for Mr Draghi to signal that exit from QE was soon to be accelerated. However a combination of still soft global inflation data and the Euro"s recent ascent has made it unlikely that the event will be a watershed moment. Expect him to be upbeat on the economy but the hawkish/dovishness indicator might be swayed one way or the other on how much attention the Euro gets in his remarks."

What about the Fed side of things? Here, according to UBS there will be nothing of market-moving either, and as the bank"s economist Seth Carpenter writes "Don"t expect news at Jackson Hole. Chair Yellen has told us what she wants to about normalization, for now. Financial stability matters, but it isn"t new" and as such it will be "nothing to skip lunch over."  Carpenter elaborates that "the annual Jackson Hole Symposium features Chair Yellen on Friday speaking on "Financial Stability." The conference has in recent years been a venue for big news in monetary policy, but this time around it is likely to be undramatic. We expect the Chair"s speech to keep to well-trod financial stability topics—some excesses may exist, but the system is safe—and eschew discussion of potential near-term policy actions."

Deutsche Bank is a little less sanguine:

Our Fixed Income Strategists now actually think that the Fed could be more important at Jackson Hole. The running theme of this year’s symposium is “Fostering a Dynamic Global Economy” and the full line up of speakers and presentations will be released at 4PM EST on Thursday. Mrs Yellen will be speaking Friday morning at 10AM EST on financial stability. Our strategists noted that in the US there is a tension between softer inflation and easy financial conditions and given the topic of Yellen"s speech is "financial stability" she may lean towards prioritising one side or the other. Overall the market will probably be most sensitive as to whether a December hike is more or less likely after her comments. The imminent halting of reinvestment seems to be considered a fine deal."

But why is UBS convinced that Friday"s events (a full logisitcal breakdown is below) will be a snooze fest? Here is the explanation"

The FOMC has told us what they want us to know on monetary policy

The FOMC has increased its communication and transparency about the normalization of its balance sheet. The big news is out. The outlook for rate hikes, Chair Yellen and the FOMC have told us, depends on the realized and expected path of inflation. Some technical details about implementation remain to be disclosed, but Jackson Hole would not be the venue. The FOMC has also been clear that they will put off decisions on the terminal size of the balance sheet until after implementation has begun.

"Financial stability" matters, but isn"t new

As we noted, the Minutes of the June and the July meetings both discussed financial stability issues. In July, "a number" of participants noted that very low long-term yields could snap back abruptly or induce excessive risk taking. Moreover, the FOMC discussed equity valuation as a possible source of financial instability along with commercial real estate. On net, however, the FOMC seems comfortable with current financial stability risks, even though they will continue to monitor developments.

So what will she say about financial stability?

We suspect that Chair Yellen will take this opportunity to discuss the distinction between financial stability considerations and financial conditions more broadly. She will take stock of the signal from historically low interest rates and the forces that determine those rates. These factors include slower potential GDP growth than historically was the case, global savings demand for very safe assets, and the Fed"s balance sheet that continues to put some downward pressure on rates. She will note that equity valuations are high by some metrics, but by others may be justified. She will spend time on tight credit spreads, especially in the context of the Fed"s monetary policy, the ongoing expansion, and generalized risk taking. Finally, she will acknowledge that parts of the Committee see commercial real estate as potentially pointing to excessive risk taking.

Well, what about financial conditions?

The Chair will take some time to differentiate financial conditions from financial stability concerns. The high level of equity prices, tight credit spreads, and low longer-term Treasury yields are much in discussion. She will note that the easy financial conditions are not, in and of themselves, a problem for monetary policy. Rather, they are one factor among many that inform her outlook for the economy. Easier financial conditions should, all else equal, support aggregate demand. In fact, as noted in Fedspeak, the Committee"s outlook for ongoing gains and higher inflation over time is supported by these conditions, not hampered by them.

What should we take away?

Very little. Overall, Chair Yellen"s speech will articulate more clearly how the FOMC thinks about financial stability issues, there should be very little that informs us on the near-term outlook for monetary policy. She will likely reiterate that the post-Crisis regulation has made the system safer. She will embrace the idea that there is room for some adjustment to the existing regulation, but she will push back against the idea of wholesale financial deregulation.

Of course, if UBS is right, any hopes of a spike in cross-asset volatility at the end of the week can be postponed yet again. Market outcomes aside, what is the agenda and logistics? Here, courtesy of Goldman, is a full breakdown:

Starting with the basics, the conference runs from the night of Thursday, August 24 through Saturday afternoon. Each year, the conference centers around one broad theme (this year it is “Fostering a Dynamic Global Economy”) and all of the presentations should be a mix of current policy discussions and the conference theme.

The full program will be released here on Thursday night at 8pm NY time. In addition to timing, this schedule will include speaker names and the title of papers they will be discussing (if applicable). It is probably worth mentioning that because the conference is in Wyoming, all times are listed in Mountain Time. That is two hours behind the US East Coast and seven hours behind London.

None of the conference is broadcast. For all of the published speeches and papers, text will be released at the scheduled time for the panel or speech and there is no televised Q+A. However, there are usually a series of sideline TV interviews across major business networks. These are conducted throughout the day with a number of Federal Reserve officials (usually around five), international central bankers and academics. Because the speeches often have more of an academic slant, these interviews can  often be the most relevant short-term news events of the day. The last couple years, Vice Chair Fischer has done an interview on CNBC during the first coffee break around 11:30 NY time.

The main events start Friday morning at 10am with the keynote speech, which we now know will be delivered by Fed Chair Yellen. So far, the Fed has only said that her speech will be on the subject of “Financial Stability.” It is obviously hard to forecast a freeform speech, so we will just make a few logistical points.

• First, since it is the keynote speech for the conference, the content of the speech should be closely tied to the conference theme of Fostering a Dynamic Global Economy.


• Second, the subject of the speech alone is not a sufficient indicator for whether or not she will comment on current policy. Last year, the subject of Yellen’s speech was listed as “The Federal Reserve’s Monetary Policy Toolkit” but she decided to include an opening section on the “Current Economic Situation and Outlook” that could just as well have been omitted.


• Third, keep in mind that this is an academic setting above all else. Although Yellen certainly knows the weight that her words carry, the Jackson Hole keynote tends to be 10-15 pages long and can include multiple pages of academic references and footnotes; this is not the kind of thing that is easily distilled into a few news headlines. Last year’s speech, with its explicit section on current policy, was probably an exception to that rule.

The keynote speech is just one aspect – albeit an important one – of a busy conference.

So far, we also know that ECB President Draghi will deliver the luncheon address on Friday at 3pm NY time. The text of his speech should be released at that time. While this could certainly change, the rest of the speaking slots on Friday are usually reserved for academics. In past years, there has also been a closing panel on Saturday around 12:25 NY time that features speeches from two or three G10 central bankers and  one from EM.

On the other end of the spectrum, the academic papers (and the topic of the conference itself) could potentially have the longest-lasting impact on the policy discussion. However, these will also be the hardest to immediately interpret. As with the speeches, the text of the academic papers will not be released until the time of the relevant panel. The title and author names will be on the program released on Thursday night.

As Goldman further adds, given the number of Federal Reserve comments likely to come out of Jackson Hole on Friday, the bank is providing its usual table of recent Fed comments with a bit of a longer history as a quick reference point. For example, Dallas Fed President Kaplan’s comment last week that he is going to be “patient” on future rate hikes was a repeat of comments he made in July.

* * *

Finally, for those who are not convinced that Draghi, who is scheduled to speak on Friday just before the market close, won"t steal the spotlight after all, Deutsche Bank reminds us that the ECB head is warming up for the trip by speaking at the Lindau economics symposium in Germany tomorrow, August 23 "and as such he could front run himself." In other words, tomorrow"s conference could be more market-moving than what happens on Friday.

"It Is A Battle Between Data And Theory" - Fed PhDs Second-Guess Inflation Model After 5 Years Of Failure

Federal Reserve officials are finally waking up to the fact that there’s something wrong with their inflation models. It only took them five years.

As Bloomberg points out, the minutes from the Fed’s July policy meeting, released yesterday, included a debate about whether the models that help the central bank set its inflation target are no longer functioning properly.

“Federal Reserve officials are looking under the hood of their most basic inflation models and starting to ask if something is wrong.

Minutes from the July 25-26 Federal Open Market Committee meeting showed a revealing debate over why the economy isn’t producing more inflation in a time of easy financial conditions, tight labor markets and solid economic growth.

The central bank has missed its 2 percent price goal for most of the past five years. Still, a majority of FOMC participants favor further rate increases. The July minutes showed an intensifying debate over whether that is the right policy response.”

Some economists worry that if the Fed begins to publicly question their methods, it could ruin what little credibility the central bank has left.

“These minutes to me were troubling,” said Ward McCarthy, chief financial economist at Jefferies LLC in New York. “They don’t have their confidence in their policy decisions; and they don’t have confidence that they can provide the right kind of guidance.”

Of course, Fed officials did everything in their power to communicate that these questions were being raised by a small minority on the FOMC, and didn’t represent anything resembling an official opinion.

“In several passages, the minutes asserted that “most” officials were sticking with a forecast that higher inflation would eventually show up. However, the debate over resource slack models and whether standard data sources were telling them the whole story also showed convictions about their forecast are fraying.”

As Bloomberg explains, prices have been resistant to any upward movement even as the US unemployment rate has fell to a 16-year low of 4.3 percent in July. The U.S. consumer price index rose 1.7 percent for the 12 months ending July, while the PCE price index, the Fed’s preferred measure, which is tied to consumption, rose 1.4 percent in June. Another gauge calculated by the Dallas Fed, which trims index outliers to highlight the underlying price trend, rose 1.7 percent for the 12 months ending June. That was the same as May, which was down from 1.74 percent in April.

A few officials pointed out what many investors have believed for years: That the Fed"s inflation forecasting model is totally useless.

“The minutes said “a few” officials described resource slack models as “not particularly useful” while “most” thought the framework was valid.

Members also questioned whether there’s another theory that might better explain the inertia in prices.

The committee also pondered a number of theories as to why inflation wasn’t responding to tightening labor resources, such as “the possibility that slack may be better measured by labor market indicators other than unemployment.”

One notable economist described it as “a battle between data and theory.”

“It is a battle between data and theory,” said Ethan Harris, head of global economic research at Bank of America Corp. in New York.

But it almost doesn’t matter that the Fed’s vaunted inflation models no longer make any sense, because, the Fed is going to keep hiking no matter what now that the risks have struck the “appropriate balance” – at least that’s what one member of the leadership (probably Chairwoman Yellen) believes.   

“The minutes also included an unusual signal that someone - possibly a member of the committee’s leadership - saw additional rate increases as striking the “appropriate balance” on policy goals, dedicating two sentences to the views of “one participant.”

“That seems like an awful lot of air time as well as a very definitive answer coming from a mere ‘one participant’ - unless that single person happened to be someone really important - like, I don’t know, maybe the Chair?,” Stephen Stanley, chief economist at Amherst Pierpont Securities in New York, wrote in a note to clients, referring to Janet Yellen.”

Maybe in whatever model they concoct to replace this one, the Fed should include a metric probably more relevant today than economists realize: The amount of time Americans’ spend on Instagram per day.
 

The Two Things To Look For In Today's FOMC Minutes

There are two, also known as non-GAAP four, things to look forward to in today"s FOMC Minutes: inflation, and balance sheet, balance sheet, balance sheet.

At 2pm, the FOMC will release the minutes of the July 25-26 meeting when, as expected, the Fed left its rate unchanged and gave few surprises in its characterization of the outlook. It did surprise many, however, by noting that it expects to begin implementing balance sheet normalization "relatively soon", language which most had not expected to be introduced until September; this, as UBS notes, is the condition the FOMC set for unwinding its balance sheet, so we now see the Fed announcing its balance sheet normalization policy in September. While there will be no earthshattering revelations, look to the Minutes to shed additional light on the Committee"s debate on this timing and views on the outlook for inflation, which will determine future rate hikes.

Going back to the July 26 statement, the FOMC"s characterization of inflation was uninformative, merely reflecting the softness in the last several prints. In the minutes, some hope to find if the language reflects strongly held views that the softness is transitory, or if there were participants that wanted to raise more alarm about the inflationary outlook, but were outnumbered. Chair Yellen has been explicit that the outlook for inflation will determine the timing of future rate hikes.

Leading up to the meeting, Fed officials were explicit that they believe that inflation weakness is transitory but that they need to see evidence that inflation is rising before hiking again. Further complicating matters, the July CPI print - the fifth miss in a row - did not provide sufficient evidence. As a result, the breadth of inflation views within the Committee should inform the sellside"s calls on the next hike.

As for the Fed"s balance sheet "normalization", the Fed has made a distinction between announcing and implementing the balance sheet runoff. The new "relatively soon" language represents a marker that the announcement is forthcoming, according to UBS. As a result, the FOMC will likely make that announcement at the September meeting, with runoff commencing in October. The Minutes need to clarify the Committee"s communication plans and the gap between announcement and implementation.

There is more ambiguity regarding whether the Fed will again raise rates: while many still hold out hope for a third hike in December, inflation has to accelerate. Still, the Committee likely desires some time between the announcement of balance sheet runoff and its next hike. Three months should be sufficient for the Committee to assess the market reaction, but the Minutes may indicate otherwise so this too will be closely parsed for any indication of a longer pause.

Finally, two areas demand more information.

• First, how will the Fed time the unwind? The MBS market has a different cycle than the Treasury market. The Fed needs to clarify operational details around their monthly caps.


• Second, there is little information from the Fed on its long-term framework for the balance sheet, which will determine the terminal size of the balance sheet. We expect the minutes to address the operational details, but not the terminal size of the balance sheet. We expect a terminal balance sheet of $3.3 trillion reached in 2¾ years.

Not enough? Here is RanSquawk"s detailed preview of what to expect in today"s Minutes:

FOMC’s July 2017 Meeting Minutes Preview, Due For Release At 19:00 London, 14:00 New York On Wednesday 16th August 2017

The July meeting saw the Federal Reserve leave it Federal Funds target range unchanged at 1.00-1.25%, with a 9-0 vote. Heading into the decision focus was on the rhetoric surrounding the normalisation of the FOMC’s balance sheet, and the policy statement (full version available here) noted that the Committee expects to begin shrinking its balance sheet "relatively soon." The statement also saw the Fed highlight that it expected inflation on a “12-month basis” to remain below 2% in the near-term (which was deemed dovish), although the statement did go on to highlight that the FOMC expects inflation to stabilise around 2% over the medium term.

The language surrounding these two areas will once again garner the most attention in the upcoming release. Barclays expect the minutes of the July FOMC meeting to “provide further information regarding the timing of balance sheet normalisation and the degree of consensus within the committee.”

While HSBC believe that “the July minutes are likely to show extensive discussion about the slowdown in inflation over the past several months. Some of the policymakers likely held to the view that diminishing labour market slack should eventually put upward pressure on inflation. Others may have argued the FOMC should be cautious with respect to additional policy rate hikes unless the inflation data start to pick up.”

Since the statement various FOMC voters, namely Dudley, Kashkari, Evans and Kaplan, have indicated that they would be comfortable with an announcement regarding balance sheet normalisation being made at the September meeting, while non-voters (including Bullard) have also backed such a move.

In terms of broader policy issues, the most recent US CPI release (for July) was soft and saw CME Fed Fund futures pricing in a sub 35% chance of one further 25bps hike in 2017, with Kashkari (a noted dove)  arguing that the release gave the FOMC more scope to “wait and see” before hiking rates again. This was before permanent Fed voter, Bill Dudley, suggested that “if the economy evolves in line with expectations, I would expect to be in favour of doing another rate hike later this year.” This was followed by a strong retail sales dataset (with upwards revisions), which has led to CME Fed Fund futures pricing a circa 50% chance of a 25bps hike by year end (at the time of writing).

Barclays believe that “balance sheet normalization will likely start in September and the hurdle is quite high for the FOMC to deviate from what it has been signalling so far. We will also look for more detail on how concerned the FOMC is with the incoming data on inflation. Although we think concern has risen, we do not believe there is sufficient worry yet to derail a likely December rate hike.

Source: UBS, RanSquawk

John Mauldin: "One Of These 3 Black Swans Will Trigger A Global Recession"

Authored by John Mauldin via MauldinEconomics.com,

Exactly 10 years ago, we were months way from a world-shaking financial crisis.

By late 2006, we had an inverted yield curve steep to be a high-probability indicator of recession. I estimated at that time that the losses would be $400 billion at a minimum. Yet, most of my readers and fellow analysts told me I was way too bearish.

Turned out the losses topped well over $2 trillion and triggered the financial crisis and Great Recession.

Conditions in the financial markets needed only a spark from the subprime crisis to start a firestorm all over the world. Plenty of things were waiting to go wrong, and it seemed like they all did at the same time.

We don’t have an inverted yield curve now. But when the central bank artificially holds down short-term rates, it is difficult if not almost impossible for the yield curve to invert.

We have effectively suppressed the biggest warning signal.

But there is another recession in our future (there is always another recession), which I think will ensue by the end of 2018. And it’s going to be at least as bad as the last one was in terms of the global pain it causes.

Below are three scenarios that may turn out be fateful black swans. But remember this: A harmless white swan can look black in the right lighting conditions. Sometimes, that’s all it takes to start a panic.

Black Swan #1: Yellen Overshoots

It is clear that the US economy is not taking off like the rocket some predicted after the election:

• President Trump and the Republicans haven’t been able to pass any of the fiscal stimulus measures we hoped to see.

• Banks and energy companies are getting some regulatory relief, and that helps; but it’s a far cry from the sweeping healthcare reform, tax cuts, and infrastructure spending we were promised.

• Consumer spending is still weak, so people may be less confident than the sentiment surveys suggest. Inflation has perked up in certain segments like healthcare and housing, but otherwise it’s still low to nonexistent.

Is this, by any stretch of the imagination, the kind of economy in which the Federal Reserve should be tightening monetary policy? No—yet the Fed is doing so.

It’s in part because they waited too long to end QE and to begin reducing their balance sheet. FOMC members know they are behind the curve, and they want to pay lip service to doing something before their terms end. 

Plus, Janet Yellen, Stanley Fischer, and the other FOMC members are religiously devoted to the Phillips curve. 

The black-swan risk here is that the Fed will tighten too much, too soon. 

We know from recent FOMC minutes that some members have turned hawkish in part because they wanted to offset expected fiscal stimulus from the incoming administration. That stimulus has not been coming, but the FOMC is still acting as if it will be.

What happens when the Fed raises interest rates in the early, uncertain stages of a recession instead of lowering them? Logic suggests the Fed will curb any inflation pressure that exists and push the economy into outright deflation.

Deflation in an economy as debt-burdened as ours is could be catastrophic. 

Let me make an uncomfortable prediction: I think the Trump Fed—and since Trump will appoint at least six members of the FOMC in the coming year, it will be his Fed—will take us back down the path of massive quantitative easing and perhaps even to negative rates if we enter a recession.

The urge to “do something,” or at least be seen as trying to do something, is just going to be too strong.

Black Swan #2: ECB Runs Out of Bullets

Relative to the size of the Eurozone economy, Draghi’s stimulus has been far more aggressive then the Fed’s QE. It has pushed both deeper, with negative interest rates, and wider, by including corporate bonds.

Such interventions rarely end well, but this one is faring better than most.

Europe’s economy is recovering, at least on the surface, as the various populist movements and bank crises fade from view. But are these threats gone or just glossed over? The Brexit negotiations could also throw a wrench in the works.

Anatole Kaletsky at Gavekal thinks Draghi is still far from reversing course. He expects that the first tightening steps won’t happen until 2018 and anticipates continued bond buying (at a slower pace) and near-zero rates for a long time after.

But he also sees risk and makes an important point.

The US’s tapering and now tightening coincided with the ECB’s and BOJ’s both opening their spigots. That meant worldwide liquidity was still ample. I don’t see the Fed returning that favor. Draghi and later Kuroda will have to normalize without a Fed backstop—and that may not work so well.

Black Swan #3: Chinese Debt Meltdown

China is by all appearances unstoppable.

GDP growth has slowed down to 6.9%, according to official numbers. The numbers are likely inflated, but the boom is still underway.

Ambrose Evans-Pritchard reported some shocking numbers in his July 17 Telegraph column.

A report from the People’s Bank of China showed off-balance-sheet lending far higher than previously thought and accelerating quickly. (Interestingly, the Chinese have made all of this quite public. And President Xi has taken control of publicizing it.)

The huge increase last year probably reflects efforts to jump-start growth following the 2015 downturn. Banks poured fuel on the fire, because letting it go out would have been even worse. But they can’t stoke that blaze indefinitely.

President Xi Jinping has been trying to dial back credit growth in the state-owned banks for some time; but in the shadow banks that Xi doesn’t control, credit is growing at an astoundingly high rate, far offsetting any minor cutbacks that Xi has made.

A market in which “they all think the government will save everything” is generally not one you want to own—but China has been an exception. It won’t remain one forever. The collapse, when it comes, could be earthshaking.

It is very possible that any of these black swans could trigger a recession in the US. And let’s be clear: The next US recession will be part of a major global recession and will result in massive new government debt build-up.

It will not end well.