Consumer Confidence Unexpectedly Drops On Inflation, Rate-Hike Fears

UMich consumer sentiment declined from 100.7 to 97.8 in the preliminary November print, disappointing expectations of a small rise as anticipation of a pickup in inflation and higher interest rates weighed on the gauge.

Even with the decline, sentiment was the second-highest since January, reinforcing other reports that Americans remain optimistic about employment and the economy.

Other highlights include:

• Consumers saw the inflation rate in the next year at 2.6 percent, up from 2.4 percent the prior month


• Consumers expected an annual income gain of 2.1 percent for the second straight month, the best two-period average since 2008


• Inflation rate over next five to 10 years held at 2.5 percent


• Six in 10 consumers saw stock-market gains as likely in the year ahead


• References to low mortgage rates fell to 32 percent in early November from 40 percent last month

Consumers (and policy makers) have four key concerns: prospective trends in jobs, wages, inflation, and interest rates. An improving labor market was spontaneously mentioned by a record number of consumers in early November, and anticipated wage gains recorded their highest two-month level in a decade. These favorable trends were countered by a slight rise in year-ahead inflation expectations and a growing consensus that interest rates will increase during the year ahead.

Americans are as exuberant about their wealth effect as they were at the peak ahead of the last crisis...

“While the majority judged current conditions in the economy favorably and consumers anticipated continued growth on balance, consumers judged the outlook less satisfactory, and were equally divided about whether the expansion would last another five years,” Richard Curtin, director of the University of Michigan consumer survey, said in a statement.

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.

What Few Expect: Inflation Will Surge, Destabilizing The Status Quo

Authored by Charles Hugh Smith via OfTwoMinds blog,

Few seem to ponder what global shortages in key commodities might do to prices.

If there is any economic truism that is accepted by virtually everyone, it"s that inflation is low and will stay low into the foreseeable future. The reasons are numerous: technology is deflationary, globalization is deflationary, central banks will keep interest rates near-zero essentially forever, and so on.

Just for laughs, let"s look at healthcare, almost 20% of America"s entire economy, as an example of low inflation forever. If being up over 200% in the 21st century is low inflation, I"d hate to see high inflation.

Here"s the official Consumer Price Index (CPI), which as many have noted, severely distorts real-world inflation by claiming big-ticket items such as college tuition and healthcare are mere slivers in household budgets.

Note the remarkably stable trend line in CPI over the past 40 years. This certainly doesn"t shout "inflation is near-zero and will stay low indefinitely."

Here"s the PCE, Personal Consumption Expenditures, the Federal Reserve"s favored measure of core inflation. Let"s put it this way: either the PCE is real and the CPI is false, or vice versa; they can"t both be accurate measures of real-world inflation.

Here"s a look at the annual rate of inflation. The go-go years prior to the Global Financial Meltdown of 2008-09 and the years of "recovery" 2010 to 2014 look very similar: some modest volatility between 1.7% and 2.5% annually.

But something changed in 2015-2017. The wheels fell off and then inflation turned up. Maybe it was nothing, maybe not. Let"s turn to a chart of asset inflation for a different perspective.

Courtesy of Goldman Sachs, here is a chart comparing asset inflation with real-world inflation. Note how assets have soared while real-economy measures have barely edged higher--commodities actually fell in price.

Now let"s look at where the gains of the "recovery" were concentrated: in the hands of the few in the top .5%. This chart depicts the unprecedented concentration of income gains in the very apex of the wealth-power pyramid. Needless to say, very little trickled down to the bottom 90%, and even the top 9.5% received mere crumbs.

So what do these charts tell us about future inflation prospects? To the conventional punditry, they suggest more of the same: higher asset valuations, low real-world inflation and near-zero interest rates (courtesy of central bank purchases of bonds and other financial assets).

I beg to differ. To me, these charts suggest real-world inflation is about to take off in the next 5 years, surprising everyone who expected more of the same. My reasoning is simple:

The leadership of the Status Quo has a simple choice: continue with more of the same, enriching the top .5% at the expense of everyone else, and face a political firestorm of upheaval, instability and insurrection, or start funneling the trillions of dollars, yen, yuan and euros that have been channeled into the hands of the few into the hands of the many.

The policy of funneling fresh cash into the hands of households has a number of variations: negative tax rates (lower income households get a hefty tax rebate annually), Universal Basic Income (UBI--every adult gets a monthly cash stipend), QE for the people (the central bank buys special government bonds that eliminate all student loan debt), and so on.

Where virtually all central bank monetary stimulus over the past 8 years went into assets, QE for the people would go right into household bank accounts where most of it will be spent in the real economy.

The incomes of the bottom 90% have gone nowhere for 8 long years. No wonder real world inflation has been capped outside of housing, healthcare and higher education. (Never mind these are the dominant expenses for the majority of households.)

So what happens when fresh trillions start flowing into the real world economy instead of into assets? If history is any guide, inflation picks up. Toss in some global shortages in key commodities and the fuel for inflation will be ready to ignite.

One part of the inflation will stay low indefinitely story is there"s an abundance of everything: grain, oil, natural gas, copper, bat guano--you name it, the world is awash in the stuff.

Few seem to ponder the possibility that this surplus of everything might be temporary, a brief run of extraordinary luck rather than a permanent abundance. Few seem to ponder what global shortages in key commodities might do to prices.

Whether you call soaring prices inflation or not, the result is the same: the purchasing power of currency declines. Every unit of currency buys less of whatever is no longer in surplus.

The funny thing about inflation is that it"s not a problem that can be solved by creating trillions more dollars, yuan, yen and euros out of thin air. Issuing mountains of new currency actually increases inflation.

Oops. Our only "fix" is to issue trillions more in new currency and credit. If that doesn"t fix the problem, the toolbox is empty.

*  *  *

If you found value in this content, please join me in seeking solutions by becoming a $1/month patron of my work via patreon.com. Check out both of my new books, Inequality and the Collapse of Privilege ($3.95 Kindle, $8.95 print) and Why Our Status Quo Failed and Is Beyond Reform ($3.95 Kindle, $8.95 print, $5.95 audiobook) For more, please visit the OTM essentials website.

"The Fed Is Afraid..."

Janet Yellen this week cast doubt on the Fed"s announced plan to continue Fed rate hikes and reverse its years of "unconventional" monetary policy. 

“My colleagues and I may have misjudged the strength of the labor market,” Yellen announced on Tuesday, adding that they"d also misjudged "the degree to which longer-run inflation expectations are consistent with our inflation objective, or even the fundamental forces driving inflation."

Yellen also "noted that the labor market, which historically has been closely linked to inflation, may not be as tight as the low unemployment rate suggests."

In other words, Fed economists are concerned by the fact they"ve been unable to achieve their arbitrary 2% price-inflation objective, which they believe indicates a healthy level of economic activity.

Moreover, they"re concerned the low unemployment rate — which can be deceptive since it can show a "tight" market even in the presence of unemployed discouraged workers and involuntary part-timers — is not telling the whole story. 

The end result is that the Fed is not at all sure that it can continue with its promised path of raising the target interest rate as has been the "plan" for the past several years. 

As we"ve noted here at mises.org before, the Fed has a habit of announcing big plans to scale back quantitative easing, and increasing the target rate — only to later backtrack or downplay the extent to which it will "normalize" monetary policy. 

Since 2009, the target rate has been at rock-bottom rates. Over the past year, the Fed has raised the target rate from 0.5 percent to 1.25 percent, but this has only gotten the rate back up to where it was when it was attempting to stimulate the economy in the wake of the dot-come bust in 2001. On other words, the Fed is still deep into "stimulative monetary policy" territory. 

And now we"re being told that the Fed may have overestimated the rate to which it can scale back monetary policy. 

Nine Years of Stagnant Incomes 

Looming over the latest admission of "miscalculating" the economy"s success is the ongoing myth that the Fed and its economists are wisely and carefully steering the economic ship to a safe port. 

Actual experience — given that the target rate was kept near zero for eight years — more suggests panic and dismay, rather than the presence of a steady hand. 

If we look at the Federal government"s own data on incomes through 2016, we find an unimpressive record indeed. 

Real median personal income, for example, peaked during the last cycle at $30,821 in 2007. This total was not exceeded again until 2016 when it reached $31,099. That"s 0.9 percent growth over a period of nine years. 

We see a similar picture with both median family income and median household income. 

Median family income grew 2.3 percent from 2007 to 2016. It grew 2.7 percent from 2000 to 2016. Growth was nearly zero from 2000 to 2015, and only began to really surpass old peaks in 2016. 

 Median household income grew 1.5 percent from 2007 to 2016. It grew 0.6 percent from 2000 to 2016. 

(See here and here for more discussion on how demographic changes can affect income growth levels.)

These number by themselves don"t prove that real incomes are flat for everyone of course. But, lackluster numbers in employment, and in GDP over the last 20 years — compared to the post-war economy overall — hardly point to a period of economic gain for many ordinary Americans. 

The Fed Is Afraid 

For years, the Fed has been telling us repeatedly that the economy is moving forward, that growth is "moderately" robust, and that they"ll return to more "normal" interest rates and more normal monetary policy. The reality has been eight yeears of no action followed by about 18 months of extremely mild and cautious increases in the target rate. 

So the question is this: if we"re seeing moderate growth month after month, and year after year, why has the Fed been too afraid to do anything except make only the smallest changes?

The answer, most likely, is that the Fed knows the economy is extremely fragile. This latest admission from Yellen serves to — yet again — manage expectations and tell us to not expect much of anything from the Fed in terms of normalization. Perhaps we"ll need another seven or eight years to get the targe rate up to 2 percent.

Goldman's Clients Are Confused About Inflation: Here's Why

In his latest weekly kickstart, Goldman"s chief equity strategist David Kostin (who has maintained his year end S&P price target of 2,400 of -3% from current levels), says that the one topic most confusing (and important) to Goldman"s clients in the past week, was what happens to inflation next: "the US inflation outlook and its equity investment implications were key topics of discussion during recent visits with clients in Boston, Chicago, and New York. Core Personal Consumption Expenditures (PCE) data released [on Friday] showed a year/year inflation rate of 1.5% in 2Q. Wednesday’s Fed statement acknowledged that inflation was running “below” its 2% target, a revision from the “somewhat below” description used previously."

Kostin points out that while fixed income managers have always had to take a view on inflation, now that the Fed"s "reaction function", to use an IMF-ism, is entirely driven by concurrent and future inflation expectations, and as a result "equity investors must also take a stand and position portfolios accordingly. The anticipated path of inflation is an important determinant of the trajectory of Fed policy tightening. Bond yields will be affected in turn via expectations of future hikes and the term premium, and stock prices by extension will be influenced through the equity risk premium."

As for why Goldman"s clients are "confused", Kostin points out something we have discussed on several occasions recently: depending on what indicators one uses, inflation can be expected to rise, drop, or stay the same: 

"Looking forward, will the rate of inflation in 2018: (a) decelerate, (b) accelerate, or (c) stay about the same? The answer depends on the information source. Treasury Inflation Protected Securities (TIPS) imply inflation will decelerate; Goldman Sachs economics forecasts an acceleration (to 1.9%); while corporate pricing varies both across and within industries. For example, branded pharmaceutical prices are rising by 9% (offset partially by rebates) while generic drug prices are falling by 9%."

Some more details behind these perplexing numbers:

• The TIPS market implies inflation will average 1.3% annually during the next two years and 1.8% annually through 2027. As a result, fed funds futures currently imply just a 50% probability the FOMC will hike once more by year-end 2017 and expect just two hikes in total through the end of 2018.


• In contrast, Goldman Sachs economics believes underlying inflation will trend towards the Fed’s 2% objective. Specifically, our economists forecast core PCE will reach 1.6% by year-end 2017 and climb to 1.9% by the end of 2018. The trend in inflation will prompt steady policy tightening starting with a 25 bp hike in December followed by four hikes in each of 2018 and 2019 that will lift the funds rate to 2.4% and 3.4%, respectively.
  

In a humorous swipe at his own economics team, Kostin writes that "we have met no equity investors who subscribe to this forecast."  So much for Goldman"s once legendary ability to shape and sway investor sentiment. 

Then there are the government"s own measurements of inflation:

The components of measured PCE inflation are split 25% in Goods and 75% in Services. The goods category has shown consistent deflation for several years and our economics team forecasts that trend will persist in 2017 and 2018 (see Exhibit 5). A leading driver of disinflation has been the Video, Audio, and Computer category where prices dropped by 5% in 2015, by 10% in 2016, are declining at an average pace of 7% YTD, and we forecast will fall by 4% and 7% in 2017 and 2018, respectively.

However, Services PCE inflation is the more important category and the trends are mixed, which is why market participants have such divergent views on the underlying pace of inflation. The four largest Services categories account for 65% of core PCE inflation and include Medical Services (19%), Housing (19%), and Financial Services (9%).

Separately, what inflation information can investors glean from corporations and the equity market?

Confirming what the latest Census data showed last week, namely that asking rents across the nations just fresh all time highs...

... Goldman flags that apartment owners suggest rental inflation remains above the Fed’s overall inflation target of 2%. Six public apartment REITs own 357,000 multifamily units (AVB, ESS, EQR, AIV, CPT, UDR). Same-store rental growth in REITs has been a leading indicator of the change in owner’s equivalent rents (OER) in the government’s housing inflation measure (Ex. 3).

Average rental growth for these REITs equaled 5.6% in 2015 and 4.8% in 2016. More notably, Kostin writes that "because analysts forecast rental growth will slow to 2.9% this year and 3.1% in 2018, housing inflation represents a fading tailwind to core PCE inflation." To be sure that would be great news to a middle class that has never had to pay more out of pocket for the monthly rent...

On the other hand, a conflicting picture emerges from the deflation observed in certain parts of Financial Services. The Investment Company Institute (ICI) reports that average fees for active equity management have dropped from 108 bp in 1996 to 82 bp today, although we doubt that one can seriously claim with a straight face that there is delfation because millionaire LPs are paying not 2 and 20 any more but 1 and 10 or less.

Meanwhile, inflation and interest rates affect equity valuations. The gap between the S&P 500 earnings yield and ten-year Treasury yield represents a short-hand measure of the equity risk premium. The gap in the “Fed Model” currently equals 320 bp (5.5% less 2.3%), below the average of the past 10 years (460 bp) but above the average of the past 40 years (250 bp).

Which brings us to Goldman"s summary: based on all the initial assumptions, Kostin"s S&P 500 price target of 2400 suggests the yield gap will narrow to 300 bp by the end of 2017. The yield gap has narrowed by 300 bp since February 2009.

Our economists forecast the Treasury yield will rise by 50 bp to 2.75% at year-end. Higher interest rates coupled with a slightly lower risk premium is consistent with our S&P 500 year-end target of 2400 (-3%). However, if inflation remains subdued and the bond yield hovers near the current level, the Fed Model would imply a S&P 500 fair value of 2650 (+7%) (see Exhibit 4).

Finally, and going back to the original underlying confusion, Goldman concludes that "whether they are bullish, bearish, or neutral, every equity investor is implicitly or explicitly taking a view on the inflation outlook." That... or simply taking a view that no matter how this latest inflation vs deflation debate plays out, the Fed and central banks will always be there, ready to bail out the wealth effect that they have so carefully cultivated over the past 9 years with $15 trillion in liquidity injections, and which nobody seriously thinks they will let go to waste just to make a statement that the market can levitate on its own without constant central bank manipulation.

"Stocks Are About To Make Dudley, Fischer, And Yellen Extremely Nervous"

Authored by Kevin Muir via The Macro Tourist

Stocks Dare The Fed

It was only a month ago Fed President Dudley was lecturing us about the dangers of overly easy financial conditions and how inflation’s sanguine performance was “transitory.” And it wasn’t like he was alone. The Fed’s generally accepted second in command, Stanley Fischer, echoed similar comments.

Well, on Friday morning about the most awkward economic news possible was released. CPI undershot, coming in at 1.6% instead of the expected 1.7%. Retail sales were abysmal, registering -0.2% instead of the forecasted 0.1% gain. And the University of Michigan sentiment numbers reflected a public who is becoming increasingly skeptical of the Fed’s rosy outlook. The actual index was 93.1 instead of the surveyed 95.0, but more importantly, expectations plumetted to 80.2 instead of 84.4.

This puts the Fed in a terrible place. It is obvious they have whiffed badly when it comes to meeting their inflation target. This morning Fed President Evans said “low U.S. inflation is a serious policy outcome miss.” Yeah, you don’t say? Well, what did you expect? Raising rates into an obvious economic slowdown will have that effect on inflation.

But you have to think Dudley and Fischer were aware of this possiblity when they made their comments about financial conditions comments. So now the real question is how much they are prepared to follow up their words with deeds.

Make no mistake, the market will test them. Given that the market is now convinced the Fed is on the sidelines, the last remaining potential bearish catalyst has suddenly evaporated. With the weight of a heavily handed Fed lifted, stocks, and financial conditions in general, will explode higher.

And when they do, it will make Dudley, Fischer, and I also assume Yellen, extremely nervous. Stocks will almost dare the Fed to raise rates.

I can’t help but be reminded of the batter in the song Paradise by the Dashboard Light. You know the line - “Holy cow, stolen base! He’s taking a pretty big lead out there. Almost daring him to try and pick him off.”

That’s the stock market. Already on third, pushing their luck, challenging the Fed to call their bluff.

I am not smart enough to know how the Fed will react. Nor do I know how far stocks might run. This is a dangerous moment.

Yet I have a few random thoughts that I am going to stew over this weekend.

Don’t look now, but the British Pound just made a quiet Friday afternoon breakout.

And although I am loathed to sell the US dollar down here, I am becoming even more enamoured with precious metals. Gold and silver have been crushed by rising US short rates. If the Fed blinks, they might be due for a nice pop.

Finally, although most stock market bulls believe a rising market goes hand in hand with a collapsing VIX, I think there is a decent chance we could have both stocks and VIX rise from here. I might play it by buying stocks and VXX, but a better way to express that view might just be outright long positions in SPX calls.

The market is at an inflection point, and it should be interesting to see how both the Fed, and market participants, deal with this new dilemma. Hold on to your hats, “here he comes, squeeze play, it’s gonna be close… Holy cow I think he’s gonna make it!”

Visualizing The Russian Collusion Investigation's Progress

Actually there is a lot of evidence that Trump colluded with the Russians to get help with the election. Only you deplorable groupies are unaware of it. The question is, do they care enough to nail him on it. The government is so dysfunctional that they may just ignore it, because they don"t have much to gain from the effort. And at this point, its not obvious what the benefit would be of taking him out. Pence would be better, but not much to the Democrats that would have to get Trump out, so why go through all that trouble to wind up with Pence?

They are concentrating on Section 25 of the Constitution, which is basically trying to prove that Trump is as crazy as a shit-house rat. I can plainly see that the man is a mental defective, but proving it legally is much harder. I don"t think they will pull it off before someone assassinates him. An assassination, as attractive as it sounds, would not be good because a large group of assholes would make a hero of Trump, and probably form an even more paranoid conspiracy group than they already belong to, which might last decades. The last thing we need is a million or so idiots worshiping a dead Trump.

It might be the best plan is just to let Trump ruin himself, like he has done in the past, but then, will he take us down with him?

Banks Begin To Mutiny Against The Fed: "If We Are Right, Central Banks Will Be Wrong"

It has been a trying time for the world"s central bankers, who for decades have been used to the "high finance" community"s adulation, derived from the deliverance of policy wrapped in so much opacity, gibberish and contradictions, that neither the central bankers, nor the markets, had any idea what was going on (see the Greenspan tenure), or dared to admit it was all meaningless drivel, resulting in phases during which the market was on "autopilot" and culminating with a bubble and subsequent crash, "rescued" by an even greater asset bubble and even greater crash, etc.

However, after generations of largely uncontested and unquestioned monetary policy where only the occasional "tinfoil" fringe blog dared to say that central banker emperors are not only naked and clueless but are also the cause of the world"s biggest problems, more and more voices are emerging to both challenge the prevailing monetary religious dogma, as well as daring to do something unprecedented: tell the truth.

One example was Bank of America"s chief strategist, Michael Harnett, who on Friday confirmed what we had been saying for years, that  "central banks have exacerbated inequality via Wall St inflation & Main St deflation" and that the Fed failed in its mission to make the poor richer, instead its destructive policies have made the top 1% wealthier beyond its wildest dreams, and have been directly responsible for such political outcomes as "Brexit" and "Trump."

Then there was the WSJ, which on the front page, led with a headline that would have been anathema for "established" (i.e. sycophantic) financial journalism as recently as a few years ago:

"Are Central Bankers Twisted Geniuses Or Bumbling Ex-Academics" the WSJ blasted on its front page, with James Mackintosh writing the following:

Are central bankers twisted geniuses manipulating the markets in order to meet their inflation goals? Or are they bumbling ex-academics whose ramblings are overinterpreted by investors besotted with their brilliance?

After last week"s "communication" debacle, and as a result of the unprecedented ongoing collapse in the yield curve and plunge in inflation expectations at a time when central banks are coordinatively hawkish resulting in ever more deflationary market outcomes, increasingly more observers have become convinced that "bumbling academics" is the correct answer.

Which brings us to the latest note by Deutsche Bank"s Dominic Konstam, who dares to go so far as to stake his team"s credibility in "fighting the Fed"saying that "If we are right, then [central banks] will be wrong" and adds that "we are biased towards a view that central bankers are not as powerful as they think they are in terms of delivering to their economic ‘targets”. Structural forces are more important."

And so, the sellside mutiny against the Fed has officially begun, nearly 9 years after we first said that the Fed"s response to the financial crisis was the biggest financial mistake in the Fed"s 100+ years of existence. Of course, DB"s phrasing is somewhat more contained - for now - but the moment has come and gone: the Fed "emperor", in this case Yellen, has been called out for being naked and this nobody can afford to ignore it any longer.

Below we present some of the key highlights from Konstam"s latest note, "Fumbling in the Dark?" which we are confident will be copied and immitated in the coming days, and may, in retrospect, have the same impact on the prevailing religious dogma involving monetary policy as Martin Luther"s 95 theses.

There is every possibility that global central banks have a good handle on the pulse of the global economy and know what they are doing. There is also every possibility that they don’t. The key will lie in the  adjustment process for risk assets, particularly equities as well as the data. And as we demonstrate below precisely because of the manner in which risk assets have performed since 2013, investors should not be complacent.

We think the apparent shift towards a more hawkish policy stance from the likes of Draghi as well as some of the smaller central banks needs to be viewed in terms of the complexity surrounding the Fed’s own normalization process. Inflation has disappointed and curve resteepening from last summer with a rise in inflation expectations has been reversed to various degrees. The fear is that all else equal more may follow. We think this is more about talking up the outlook than having any exceptional insight into the future.

We have been arguing the Fed (but also some other central banks) have bemoaned the flattening and shifting lower of the Phillips curve but remain hopeful that it will reverse. The “explanation” partly lies in the hope that there are non linearities in the relationship and wage inflation can suddenly kick up and/ or NAIRU may be being mis-estimated and so once we find NAIRU, the Phillips curve will “recover”. Equally important is a central bank self-justification that inflation targeting reinforces the Phillips curve. As the ECB has recently argued the existence of the Phillips curve relationship makes central bank policy easier in that it allows for a closer control of inflation outcomes implying less output gap sacrifices. Inflation expectations can be rapidly brought under control, when inflation is rising too much; and on the downside, falling inflation expectations can be pre-emptively stabilized allowing for more effective monetary policy through avoiding the classic liquidity trap (real rates are allowed to fall). The  fact that the central banks have had a poor record in reaching their inflation target is therefore of great concern in that it maybe undermining the Phillips curve. Therefore emphasizing that inflation is alive and well, perhaps even threatening to raise the inflation target as the IMF has suggested is a rationale reaction to the evidence to date.

While the Fed"s grand, and hopefully final Phillips curve experiment will soon be over (spoiler alert: it will be an epic disaster), the market is far more interested by a different offshoot of Fed policy: the Fed"s support and levitation of risk assets, and what happens now that all central bankers are seemingly warning investors to take profits as equities are "overvalued." Here is Konstam:

The Fed also continues to be wary around the solid performance of risk assets which, in part thanks to the dollar, allowed for easier monetary conditions overall (FCI). Monetary tightening is supposed to tighten financial conditions and if it doesn’t, presumably there is a case for either more tightening or something to dampen FCI with the view that otherwise imbalances might develop that could threaten the longer term growth and inflation outlook. Easier FCI therefore is a foil to being more alert to inflation risk as and when (or if and when?) the Phillips curve kicks in.

* * * 

Whether or not the Fed needs to tighten financial conditions is the key question. Someone like Dudley clearly thinks it’s a good idea and Yellen while not explicitly targeting financial conditions, implicitly may have sympathy. And very obviously in late December 2015, when the Fed started to hike, only to call a year’s time out after the China mini crisis, that was all about financial conditions tightening too much .

We think there is a perfectly reasonable equilibrium where the Fed ignores financial conditions and tolerates further positive performance in equities in particular, with the weaker dollar, that ultimately allows for a better balanced recovery via stronger productivity. This would materialize in terms of our empirical models via a higher Tobin’s Q (ratio of equity market value to replacement cost value) that raises the investment rate and real investment growth which in turn raises the capital labor ratio and therefore productivity growth. It is the richness of equities that will encourage corporates to invest rather than  buyback their own stock or even others’. The buyback machine is a natural equity response to QE in that it is an “equity QE” side effect as equities look too cheap versus rates.

From a practical standpoint, Konstam focuses, as he traditionally has, on how future economic events will impact (reflexively) the term premium, inflation breakevens and the equity - and thus the Fed"s - response, a topic which BofA expanded on last week in "The Paint May Be Drying, But The Wall Is About To Crumble": BofA Explains What The Market Is Missing." Here he finds something interesting: the fate of stock prices may be far more closely tied to the BOJ than the ECB, or Fed:

[our model] highlights the relative importance of BoJ purchases to Fed and ECB. For a 100 bn in annualized purchases of each, the BoJ has been associated with a 15 bps decline in term premium, almost twice the impact of either the Fed or the ECB. While the market is rightly concerned about the extent and timing of ECB taper, the BoJ is potentially much more important to the rate outlook as it was in the middle of last year.

We, for one, can"t wait for the S&P to tremble and soar with every hiccup by Kuroda. And while DB does not reach a specific conclusion, suffice to predict that the Fed is now on a wrong path, it does highlight just how schizophrenic the central bankers have become in a time when they are forced to one thing, and then its opposite in hopes of achieving the same outcome:

Deutsche also points out the schizophrenic nature of the Fed"s "reaction function" if such a thing can even be said to exist any more, and why policy error is now virtually assured:

Ironically, in other times, central banks might have been expected to talk about more accommodation not less in the face of flatter yield curves and lower inflation expectations. In talking up inflation and talking down accommodation we think they hope to achieve the same result. It is a very different script which is understandable but not necessarily proven to succeed. It falls into the same category of thought that higher rates stimulate growth not lower rates and reflects complex models around the role of forward guidance and the formation of (inflation) expectations. It is understandable also why many investors lament an impending “policy error” as a result.

It is understandable. What isn"t understandable, however, is why the S&P remains just a few points away from its all time highs now that one bank after another has started to point out that the emperor has been naked all along.

One Fed President Says The Rate Hike Decision Was A Choice "Between Faith And Data"

Over the years many have accused central banking of being the world"s latest (and most profitable) religion, with central bankers the only modern day priests left that still matter (to the tune of $75 trillion, the market cap of all stocks in the world).

Today, in a blog post from Minneapolis Fed president Neel Kashkari explaining why he dissented from the latest Fed rate hike decision, he admits as much when he says "for me, deciding whether to raise rates or hold steady came down to a tension between faith and data. On one hand, intuitively, I am inclined to believe in the logic of the Phillips curve: A tight labor market should lead to competition for workers, which should lead to higher wages. Eventually, firms will have to pass some of those costs on to their customers, which should lead to higher inflation. That makes intuitive sense. That’s the faith part."

In a surprisingly honest assessment, he then says that "unfortunately, the data aren’t supporting this story, with the FOMC coming up short on its inflation target for many years in a row, and now with core inflation actually falling even as the labor market is tightening. If we base our outlook for inflation on these actual data, we shouldn’t have raised rates this week. Instead, we should have waited to see if the recent drop in inflation is transitory to ensure that we are fulfilling our inflation mandate."

Which inductively suggests that the rest of the FOMC is still driven by, well, faith alone. Unfortunately, this time the faith has consequences, and as Citi"s Matt King explained earlier, the Fed"s decision to not only hike rates but also to begin a $450 billion annual reduction in its balance sheet, will have "significant adjustment in valuations."

Which is perhaps ironic, because while Kashkari"s opinion is quite objective on the topic of America"s economic realities, he continues to be disappointing blind about the Fed"s true purpose, namely to prop up asset prices, to wit:

"while some asset prices appear elevated, I don’t see a correction as being likely to trigger financial instability. Investors would face losses from a stock market correction, but it’s not the Fed’s job to protect investors from losses. Our jobs are to achieve our dual mandate and to promote financial stability."

Which is funny, because while the priests over at the Fed continue to live in their ivory towers, everyone figured out what was going on, and as Citi said earlier this week,"the principal transmission channel to the real economy has been lifting asset prices."

Kashkari"s full Kashsplainer can be found here.

What Everyone Will Ask Kuroda Today: Why Has The BOJ Has Already Tapered QE By 45%?

Unlike Wednesday"s FOMC decision, few are excited about tonight"s BOJ announcement in which Kuroda is expected to announce no changes; in fact the biggest mystery is what time the "fluid" meeting will take place. What little suspense there is in Kuroda"s remarks, will likely be confined to his comments during the press conference about the BOJ"s exit strategy.

For those who plan to stay up in hope of catching some of the USDJPY volatility upon the BOJ announcement, here is a recap of what to expect from BofA:

We expect the Bank of Japan to remain on hold at its 16 June monetary policy meeting (MPM), keeping both its targets for rates and risk asset purchases unchanged. We also think the policy board will retain the "about ¥80tn" guideline for JGB purchases and refrain from announcing official tapering out of concern that doing so may send an unintentionally hawkish message to the markets. The central bank has every reason to be cautious. Growth has been running well above potential in 1H17, but price pressures remain weak, with BoJ-style core inflation (CPI ex fresh food and energy) languishing at 0.0% as of April. Downside risks to the inflation outlook suggest the BoJ is nowhere close to hiking rates or shrinking its balance sheet.

However, with the media and some members of parliament expressing increased interest in the BoJ"s "exit strategy", we believe it will be a focal topic at Governor Kuroda"s post-MPM press conference. But we doubt he will say anything new. The governor will likely remain cautious in his communications, reiterating that the central bank is not yet considering specific plans, given the 2% inflation target remains a long way away.

The Sankei Shimbun recently reported that the BoJ board will consider upgrading its overall assessment of the economy at the 20 July MPM, when it updates its estimate of the output gap in the next quarterly Outlook Report. However, risks to the board"s FY17 Japan-style core inflation forecast of 1.4%YoY are tilted firmly to the downside, in our view, especially if commodity prices stay at current levels. Another downgrade to the board"s CPI forecasts seems likely in July, or by the October MPM at the latest. In our view, the last thing the BoJ wants to do in this situation is to signal policy tightening.

In the absence of policy changes, the focus will be on Governor Kuroda"s post-MPM press conference, scheduled for 3:30pm JST. We expect the Q&A to be dominated by two themes: (1) the BoJ"s latest stance on an exit strategy from ultra-accommodative monetary policy and (2) the seeming contradiction between the policy board"s commitment to increase its JGB holdings at an annual rate of "about ¥80tn" and the ongoing slowdown in the central bank"s bond purchases, which we now estimate is running at about ¥60tn.

But before we get into BofA"s discussion of these two topics, it is worth reminding readers of something we first noted three months ago: the BOJ is quietly engaging in stealth tapering of its QE, for the same reason that the ECB will have no choice but to taper its own purchases - it is running out of eligible bonds to buy.

In a report by JPM, the bank calculates that in May, the Bank of Japan bought just Yen7.89 trillion ($71.6 billion) worth of Japanese government bonds. This was the the least outright buying since October 2014, when the central bank surprised markets by saying it would increase its asset purchases. Since launching its own version of QQE (before it twisted into Yield Control), the central bank has kept in place its target of increasing bond holdings each year by "about" Yen80 trillion. However, at the current rate of buying, the WSJ writes, the holdings are set to rise this year by only about Yen55 trillion.

The central bank is "technically tapering," said Hiroshi Shiraishi, senior economist at BNP Paribas in Tokyo. This can be clearly seen in the following chart from Bank of America.

Aside from the a declining supply of bonds held by the private sector, one tactical reason why the BOJ may be buying fewer bonds is its "yield curve control" policy, which aims to keep the yield on 10-year government bonds at zero. This implies it can buy fewer bonds when the yield is close to that target. Wednesday, the yield was at 0.06%.

Previously, Kuroda has acknowledged this slowdown, but has been quick to declare that what effectively amounts to a 35% taper doesn"t signal a retreat from easy-money policies. "At this stage, we are not exiting," Kuroda said at The Wall Street Journal"s CEO Council meeting in Tokyo on May 16.

Yes but what happens when the BOJ officially announces the need to start tapering? And more importantly, what will be the reaction of the market, which has so far taken the "technical tapering" in stride, in the country where the central bank already owns over 43% of all Japanese government bonds, and where the BOJ"s balance sheet is 90% of GDP?

So, here is Bank of America again explaining what Kuroda will likely respond if and when asked about (1) the BoJ"s latest stance on an exit strategy from ultra-accommodative monetary policy and (2) the seeming contradiction between the policy board"s commitment to increase its JGB holdings at an annual rate of "about ¥80tn" and the ongoing slowdown in the central bank"s bond purchases, which we now estimate is running at about ¥60tn.

We think Governor Kuroda"s communications will remain cautious in response to both issues. Attention on the BoJ"s exit strategy has increased since Bloomberg reported in an 8 June article that the BoJ was considering "re-calibrating its communications to acknowledge that it is thinking about how to handle a future exit from monetary stimulus, without giving the impression that this is on the agenda anytime soon." At the same time, opposition lawmakers have raised greater concerns over the BoJ"s financial health when the central bank eventually raises interest rates and have pressed the central bank to disclose detailed exit plans and its associated costs. While the Bloomberg article did not contain any new information, in our opinion, it ended up causing some volatility in the markets, suggesting investors will remain sensitive to Governor Kuroda"s comments. For this reason, we think the governor will likely say very little on the subject.

On slowing JGB purchases, Governor Kuroda is likely to acknowledge-as he has in recent Diet hearings-that the rate of increase in the central bank"s JGB holdings has recently fallen to around ¥60tn on an annualized basis. However, we expect the governor to stress that the slowdown in JGB purchases does not reflect intentional "tapering" but reflects an automatic adjustment mechanism under yield curve control (YCC). In other words, the slowdown in BoJ bond buying is a result of reduced upward pressure on JGB yields, reflecting a fall in US rates.

In other words, Kuroda will hope that the BOJ"s communication remains on autopilot. Still, at a time when the Fed just laid out what its balance sheet normalization would look like, and when even the ECB has "trial ballooned" it will soon follow, the discussion will inevitably turn to the most sensitive topic facing not only the BOJ, but Japan itself: how does the central bank hope to reduce its gargantuan balance sheet, which recently surpassed that of the Fed. Here is BofA"s answer:

The BoJ has continued purchasing significant amounts of JGBs for over four years under its QQE policy, and consequently its balance sheet has ballooned to over ¥500tn, comparable in size to Japan"s GDP. Various side effects have emerged. Since the beginning of 2016, the BoJ has carried out more JGB lending through Securities Lending Facility operations, a sign that the market shortage of JGBs has become more serious. Moreover, the repo rate plunged near the end of FY16 (March 2017) due to strong demand for TBs. Recently, the BoJ has reduced its purchases of short- and medium-term JGBs, so its Securities Lending Facility operations have also dwindled. The rise of short- and medium-term yields shows supply-demand has eased somewhat. However, if investor demand (and not necessarily such strong demand) turns to JGBs again, the risk is rising that supply-demand will tighten and prices will be distorted.

Naturally the BoJ knows this very well, so last year it introduced yield curve control (YCC) as a step on the way to making monetary policy more sustainable. So far the BoJ has succeeded at maintaining yields near targeted levels, and it has quite smoothly reduced its JGB purchases. The year-on-year increase in the BoJ"s holdings of JGBs has declined to about ¥70tn, well below the guideline figure of ¥80tn. If the current purchasing pace is maintained, YoY growth in holdings will decline even more. The BoJ"s gross annual purchases amount to about ¥96tn now, and at the end of May it held ¥43tn of JGBs that were set to be redeemed within one year, so its net purchasing pace is around ¥53tn now. For five months from January to May 2017, the BoJ increased its JGB holdings by ¥30tn, and if the current purchasing pace is maintained, its JGB holdings should increase by about ¥60tn in 2017.

Whatever explanation Kuroda comes up with, the reality is that the "liquidity impulse" generated from purchasing ¥53tn vs the designated ¥80tn, represents a greater than 30% reduction. And sooner or later, the market will realize that the liquidity added to the market by the BOJ is nearly half of what it should be in theory. That moment could result in a rude awakening, as it will likely come as the Fed continues to tighten its own monetary policy with the ECB potentially starting to tighten too as it is about to run out of eligible Bunds to buy. So how will the BOJ proceed? Here, again, is BofA:

We think the BoJ will find it difficult to change policy for the time being, so the JGB market"s volatility might stay low for a while. However, as the economic recovery deepens and domestic inflation picks up, it would not be surprising to us if the BoJ increased its communications with the market and put more effort into forming a consensus about its exit from QQE. Of course, it will proceed cautiously to avoid sudden yield surges and yen appreciation. If some conditions are fulfilled-inflation rises to about 1% and the Fed and ECB proceed steadily towards monetary normalization-it is possible the BoJ shifts from excessive easing to a more sustainable monetary policy even if its exit lies well in the future (The BoJ"s public and private face). One risk is that an unexpected event triggers global risk avoidance leading to lower yields and a simultaneous round of yen appreciation. For example, even if the 10yr yield fell far below its target, a reduction in JGB purchases could prompt further strengthening of the yen. Steering this course would not be easy. In that case, the BoJ would probably need to take countermeasures such as setting a minimum yield and continuing with its purchase operations.

Finally, here is Bank of America"s take on what the BOJ"s action could mean for the Yen:

The BoJ is widely expected to leave its policy unchanged, and the Fed"s stance and US data will be the predominant concern for the USD/JPY. We believe the BoJ is careful about not sending the wrong signal about a policy exit when the financial market is questioning the strength of the US and Chinese economies, and Japanese inflation measures are hovering around 0%. Instead, the market is likely to focus on upcoming US data to judge if the Fed is right about its policy normalization plan, forcing the market to catch up, or the Fed has to adjust toward the dovish market expectation.

We argued that self-sustained USD strength may need more time to materialize such that Japanese equities may be a better position for now. In fact, our US strategists argue it could take a few more months to know whether the US will reform its tax system. We prefer being long NZD/JPY for now while we fundamentally remain constructive on USD/JPY.

In short, for now the BOJ remains on autopilot, which is why don"t expect much from today"s BOJ announcement.

When Will Janet Live Up To Her Reputation?

Authored by Kevin Muir via The Macro Tourist blog,

I am asking you to put aside all your notions about monetary policy for a moment, and think about the next couple of points with an open mind. Forget about scary Central Bank balance sheets. Fight the urge to worry about the unprecedented quantitative easing programs. Dismiss the warning cries of the frightening levels of debt. Ignore the apocalyptic forecasts of coming stock market crashes. Let’s just have a look at the data. And most of all, let’s not worry about what should be done, but think about what will be done.

Rightly or wrongly, the Federal Reserve has a dual mandate. They are tasked with maximizing employment and maintaining price stability. Although many will debate what constitutes price stability, the Federal Reserve has interpreted it as a 2% inflation rate. You might think this absurd, so be it. It is what it is. Complaining will get you about as far as yelling at clouds.

When Janet Yellen took the reins of the Federal Reserve, many pundits predicted a period of exceptionally easy monetary policy as she was widely viewed as a uber dove. But has her reputation proved deserved?

The Fed’s preferred inflation gauge is the PCE Core Index. Don’t forget the 2% rate is a target over the long run. So if the Fed was meeting their objective, we should see half the observations above 2%, with the other half below 2%. Just for kicks, I put together a histogram of the PCE YoY% rate since Yellen took over.

Some dove. Yellen has consistently undershot her inflation mandate. Contrary to what most believe, Janet has been one of the most hawkish Central Bankers out there.

Why then does everyone think she is so dovish? Too many are focused on the Phillips Curve and are convinced the low employment rate will usher in higher inflation rates.

If you are a Phillips Curve disciple, it seems like the Federal Reserve is way behind the curve, and that Janet Yellen is being irresponsibly easy. When combined with the low nominal rates and the elevated Fed balance sheet, it is easy to fret about the fact that Janet is not raising quickly enough.

Yet what is the market telling us? The US Treasury yield curve has been flattening ever since Yellen took over.

The bond market is speaking, but most aren’t listening. It is telling us that Yellen is tightening too quickly. Or at least, she is by no means anywhere near as easy as the popular narrative.

Could it be that the bond market understands labour dynamics better than the supposed labour expert Janet Yellen?

The Phillips Curve was at best a dubious rule, but in the current environment, it is next to useless. Does anyone really believe the government statistic of a 4.3% unemployment rate?

Here is a great chart from Meridian Macro Research that shows the employment-population ratio versus the unemployment rate.

So let’s think about the current situation. We have a perceived dovish Fed Chairperson who has failed miserably to achieve her inflation target, and although the other half of her mandate appears on the surface to be bumping against constraints, the idea that she has maximized employment is laughable. As she tightens, the bond market smells the coming slowdown (recession?) and flattens the yield curve.

I know this flies in direct opposition to the common belief that Yellen is a super dove who is way behind the curve. But if you take a step back and look at her record, it is a difficult case to make. She is undershooting her inflation mandate by a wide margin.

Now you might believe that target ridiculous, and Yellen should immediately crank rates to return monetary policy to sane levels. Yeah, I understand that argument, but it’s not relevant. The Fed is not about to change its stated goal (unless to raise their inflation target). I suggest you forget your complaints, and go back to yelling at kids to get off your lawn. I am just going to accept the Federal Reserve as another Central Bank that will inevitably debase our hard earned money. And the next big surprise will not be Janet becoming even more hawkish, but instead, Yellen living up to her reputation as an uber dove.

Central Bank Hubris Bubbles To The Surface

Authored by Mike Shedlock via MishTalk.com,

Albert Edwards at Societe General commented yesterday on Central Bank Hubris, deflation, and the flattening of the US yield curve. Here are some email snips.

How’s this for Grade 1 central bank hubris?

Peter Praet, the ECB’s chief economist said in a recent interview that, “Since the crisis, we have had serious concerns about deflationary risks on several occasions in the euro area, but now we can say they have disappeared.”

Really? Has he seen the chart above, which shows core CPI in the Eurozone heading sharply lower and now approaching its all-time low seen at the start of 2015! Not only that, but Eurozone inflation expectations are also declining again, after surging in the aftermath of Donald Trump’s election. To be fair, Praet was focusing on the rise in headline inflation in the Eurozone, which touched 2% in February before dropping back in March to 1½%. After some 18 months bobbing around the zero mark, I can understand why central bankers might be heaving a sigh of relief, but for them to take credit for a recovery in headline inflation is totally disingenuous given it has been entirely driven by a recovery in the oil price.

Similarly, Janet Yellen was quoted saying the Fed is “doing pretty well” in meeting its congressionally mandated goals of low and stable inflation and a full-strength labor market. It’s this sort of comment that has led Marc Faber to want to short central bankers, the only way being to buy gold. The increasing volume of central bank hubris may even explain the recent breakout of gold to the upside!

It is not just eurozone inflation expectations that seem to be in retreat. The same thing is happening in the US too (see chart below). I am always surprised how dominated 10y inflation expectations are by short-term movements in the oil price and headline inflation, but it was noticeable just how rapidly inflation expectations ran up in the wake of Trump’s election – way in advance of what might have been expected by the bounce in the oil price.

One might have thought the surge in the oil price from its trough some 12-18 months ago might have had more impact on wage inflation, but so far that does not seem to be the case.

Despite the euphoria in the markets about the “reflation trade”, survey inflation expectations have continued to drift downwards. One thing is certain: for central banks to call victory over deflation may prove very premature indeed. Nemesis awaits.

Reflation Trade Is Over

The reflation trade is over. It is fitting central banks now brag about oil-related and Trump-related phenomena over which they had zero control.

Fed's Kashkari Responds To Zero Hedge: "A Market Drop Is Unlikely To Trigger A Crisis"

Former Goldmanite and current Minneapolis Fed president, Neel Kashkari, conducted another #AskNeel session on Twitter where the dovish FOMC voter (he was the only one to dissent in last week"s rate hike decision) received numerous question. Among them was the following one from Zero Hedge:

.@neelkashkari You recently admitted the Fed has a "third mandate." What is the biggest S&P drop the Fed will accept before intervening?

— zerohedge (@zerohedge) March 21, 2017

His response:

Don"t care about stock market fall itself. Care abt potential financial instability. Stock market drop unlikely to trigger crisis. #AskNeel https://t.co/Cv7ENuJuqU

— Neel Kashkari (@neelkashkari) March 21, 2017

At this point we would like to "timestamp" Kashkari"s claim that a "stock market drop is unlikely to trigger a crisis"

It was not clear just how the Fed president separates a market crash from "financial instability", but Kashkari"s response that the Fed is not concerned about the level of the S&P500, and instead is more focused on comprehensive market stability, is not being taken well by the market which has continued to sell off as Kashkari responds to further questions, among which the following exchanges:

In response to a question about rising inflation, Kashkari said he would tolerate 2.3% inflation for as long as U.S. has had below-target inflation, “if we really believe 2% is a target. That is what a target means" and adds that “Not sure if my colleagues wld really buy into that however." We wonder how that question would look like if instead 2.3% inflation one used 3.6%, which is the current true level of inflation according to PriceStats. At least the Fed has been polite enough to advise America it will tolerate a material "overshoot" in its inflation target.

When asked about the two latest rate increases, he said that “data didn’t support a hike. Data basically hasn’t changed. Moving sideways rather than toward dual mandate.”

He also said that he would like to see plan on balance sheet normalization soon, adding: “I would prefer to see it before we increase the federal funds rate again” and added that the balance sheet “needs to grow as economy and demand for dollars grows. We will shrink but not to 2006 levels.”

In shor, Kashkarhi - who allegedly does not care about the level of the  S&P500 - is willing to risk a market crash and a Fed balance sheet-driven bond tantrum. Or, to paraphrase Richard Breslow, "The Fed Is Making This Up As They Go Along""

"This Is Not The Reaction The Fed Wanted": Goldman Warns Yellen Has Lost Control Of The Market

With stocks soaring briskly around the globe following Yellen"s "dovish" hike, and futures set for a sharply higher open with the Nasdaq approaching 6,000, something surprising caught our attention: in a note by Goldman"s Jan Hatzius, the chief economist warns that the market is overinterpreting the Fed"s statement, and Yellen"s presser, and cautions that it was not meant to be the "dovish surprise" the market took it to be.

Specifically, he says that while the FOMC delivered the expected 25bp hike, with only minor changes to its projections. "surprisingly, financial markets took the meeting as a large dovish surprise—the third-largest at an FOMC meeting since 2000 outside the financial crisis, based on the co-movement of different asset prices."

Even more surprisng is that according to Goldman, its financial conditions index, "eased sharply, by the equivalent of almost one full cut in the federal funds rate."

In other words, the Fed"s 0.25% rate hike had the same effect as a 0.25% race cut!

The implication from the market"s reaction is that at current levels, financial conditions are poised to make a substantial positive contribution to growth in 2017, from a starting point of essentially full employment, inflation close to the target, and a sub-1% funds rate; which in light of concerns about an economic overheating due to Trump"s fiscal policies is precisely the opposite of what Yellen wants. Hatzius warns that "the FOMC will lean against this, and will deliver more monetary tightening than discounted in the bond market."

It gets better: Goldman"s chief economist - like virtually all other carbon-based market participants - admits he was stunned by the market reaction to the Fed rate hike. While Hatzius agrees that the general direction of the market response makes sense, "the magnitude greatly surprised us" and adds that Wednesday"s price action was scored by Goldman"s models "as the third-biggest dovish surprise at an FOMC meeting since 2000, at least outside the financial crisis."

And the punchline: when asked rhetoricall if "the FOMC was aiming for this outcome?", Hatzius says "No, almost certainly not."

The committee may have worried that a rate hike—especially a rate hike that was not priced in the markets or predicted by most forecasters as recently as three weeks ago—might lead to a large adverse reaction on the day, and wanted to avoid such an outcome by erring slightly on the dovish side. But we feel quite confident that they were not aiming for a large easing in financial conditions. After all, the primary point of hiking rates is to tighten financial conditions, perhaps not suddenly but at least gradually over time. And even before today’s meeting, at least our own FCI was already fairly close to the easiest levels of the past two years and this was likely one reason why the committee decided to go for another hike just three months after the last one.

In other words, whether on purpose or otherwise, according to Goldman the Fed, which now wants to tighten financial conditions (i.e., see asset prices lower) not only achieved the opposite, but has now lost control of the market.

So "how will the committee respond to this potentially undesired move?"

At the margin, it will likely make them more inclined to tighten policy. Using today’s estimated close, our FCI impulse model now implies a boost of about ½pp to real GDP growth in 2017, from a starting point of roughly full employment and inflation close to the target. So further FCI easing implies at least some risk of economic overheating—which in turn would increase the risk of recession further down the road. We expect the committee to lean against such an easing over time.

Our modal forecast remains for a total of three hikes this year, with remaining moves at the meetings in June and September, followed by four hikes each in 2018 and 2019. We see a 60% subjective probability that the next hike occurs at the June 2017 meeting, 10% for July, and 20% for September. We also expect an announcement of gradual balance sheet rundown in December; if this does not occur, the likelihood of a fourth 2017 hike would increase.

Of course, if the first of two, three or four rate hikes in 2017 is any indication, the market, already sloshing in trillions of excess liquidity, will simply take the Fed"s next tightening as an indicator of easing, and send risk assets to even more obscene highs.

* * *

Here is the full Q&A from Hatzius on why following the Fed"s 3rd rate hike in a decade, "Financial Conditions Move in the Wrong Direction":

Q: What surprised you at today’s FOMC meeting?

A: There were certainly a few dovish surprises, relative to both our expectations and our read of the consensus. First, none of the FOMC participants who projected three hikes or less for 2017 in December seems to have moved to four hikes or more; we expected two participants to move up, and some forecasters had even projected an increase in the median to four hikes. Second, the Fed’s estimate of the structural unemployment rate declined by a tenth to 4.7%; this coincides with our own estimate, but we didn’t expect the committee to make this move today. Third, we did not expect Minneapolis Fed President Kashkari to dissent in favor of unchanged rates, and we don’t think others did either. Fourth, the explicit statement that the inflation target is symmetric also came as a surprise, to us and likely others. And fifth, the statement was modified to say that the committee looks for a “sustained” return to 2% inflation.

Q: So was it a big dovish surprise overall?

A: It didn’t seem like it to us. First, the surprise in the dots, while real, seemed fairly small compared with past SEP meetings, with no changes in the median number of hikes in 2017 and 2018 or the median long-term funds rate. Second, the structural unemployment estimate moved only 0.1 point, has been trending down for several years, and is still above the committee’s forecast for the actual rate. Third, the predictive power of dissents from regional Fed presidents—especially dissents against a move that the committee is making, as opposed to dissents in favor of a move the committee has not yet made—is limited. Fourth, Fed officials have often noted that their inflation target is symmetric; moreover, the move seemed to be “defensive” in nature, as Chair Yellen noted in the press conference that it was designed to take the sting out of the recognition that there is no longer a sizable “current shortfall” in inflation. And fifth, the word “sustained” may have been equally defensive in nature, clarifying that a temporary rise in (headline) inflation to 2% or more is not, on its own, sufficient to meet the committee’s goal.

Moreover, there were also a few slight hawkish surprises. First, in the press conference, Chair Yellen declined the invitation to give much meaning to the word “gradual”; in fact, she noted that “…rates were raised at every meeting starting in mid-2004, and I think people thought that was a gradual pace, measured pace…” although she hastened to add that the committee is not envisaging “anything like that.” Second, the median pace of hikes in 2019 rose to 3½ from 3. These are minor, but they illustrate that not all the news was dovish.

Q: So what do you make of today’s market response?

A: The direction makes sense, but the magnitude greatly surprised us. As shown in Exhibit 1, our factor model for discerning monetary policy surprises from the co-movement of different asset prices scored today"s price action as the third-biggest dovish surprise at an FOMC meeting since 2000, at least outside the financial crisis. (The only two non-crisis meetings that were clearly bigger were the August 2011 move to calendar guidance and the September 2013 decision not to taper QE; the March 2015 and March 2016 cuts in the dots were similar to today’s move.) And as shown in Exhibit 2, our FCI eased by an estimated 14bp on the day—about 2.3 standard deviations and the equivalent of almost one full cut in the funds rate—and is now considerably easier than in early December, despite two funds rate hikes in the meantime. Our interpretation is that markets must have been positioned for much more hawkish news than we had thought.

Exhibit 1: According to Our Factor Model, This Was a Large Dovish Surprise

Exhibit 2: Our FCI Has Reversed Most of the Recent Tightening

Q: Do you think the FOMC was aiming for this outcome?

A: No, almost certainly not. The committee may have worried that a rate hike—especially a rate hike that was not priced in the markets or predicted by most forecasters as recently as three weeks ago—might lead to a large adverse reaction on the day, and wanted to avoid such an outcome by erring slightly on the dovish side. But we feel quite confident that they were not aiming for a large easing in financial conditions. After all, the primary point of hiking rates is to tighten financial conditions, perhaps not suddenly but at least gradually over time. And even before today’s meeting, at least our own FCI was already fairly close to the easiest levels of the past two years and this was likely one reason why the committee decided to go for another hike just three months after the last one.

Q: How will the committee respond to this potentially undesired move?

A: At the margin, it will likely make them more inclined to tighten policy. Using today’s estimated close, our FCI impulse model now implies a boost of about ½pp to real GDP growth in 2017, from a starting point of roughly full employment and inflation close to the target. So further FCI easing implies at least some risk of economic overheating—which in turn would increase the risk of recession further down the road. We expect the committee to lean against such an easing over time.

Q: So what do you expect from the Fed for the rest of 2017?

A: Our modal forecast remains for a total of three hikes this year, with remaining moves at the meetings in June and September, followed by four hikes each in 2018 and 2019. We see a 60% subjective probability that the next hike occurs at the June 2017 meeting, 10% for July, and 20% for September. We also expect an announcement of gradual balance sheet rundown in December; if this does not occur, the likelihood of a fourth 2017 hike would increase. At the margin, today’s FCI move has increased our conviction that the committee will need to deliver more tightening than priced in the markets at this point.