Speculating On Future Fed Policy

My edge when it comes to speculating on future monetary policy is that I remain objective when making projections. The so called ‘Fed skeptics’ have been closer to projecting actual Fed policy than mainstream investment bankers and commentators. The Fed itself has also had a terrible track record at predicting its own policies. This is by design. If you asked members of the FOMC about future policy behind closed doors, they would likely be willing to tell you low interest rates are going to last much longer. This is similar to what we’ve seen in the Wikileaks reports about how the Democratic officials admit the economy is weak in private, but talk about how great it is in public.

As I explained in the article yesterday, the Federal Reserve is now pushing for rate hikes more than it has all year. This is combined with a bizarre notion that the Fed is more likely to raise rates in December because it raised rates last December to push the chances of a rate hike higher. The reason it is bizarre is because there is nothing special about December which makes it ripe for a rate hike. It is merely the last month of the year for the Fed to save credibility after posturing that there would be 4 rate hikes in 2016 at the beginning of the year.

I think this aspect of the market giving the Fed more credibility because it is December is problematic for the Fed because it already has to talk up the economy because of the election. Not only does the Fed want to avoid shocking the market when it comes to policy announcements, but it also wants to avoid sharp changes in the odds of a rate hike which are shown below.

chances

The reason the Fed doesn’t want to have odds to be high in November is because when it starts to talk down the chances of a rate hike it will have to come up with a reason for doing so. Normally this isn’t that difficult, but if the odds are near 70%, there will have to be a significantly weak data point to change policy. The Fed does a great job at this posturing because it always claims to be data dependent. This doesn’t lock the Fed into any decision. Give that the data has been mixed for the majority of this recovery, there is always a data point to lock onto which will tell either a bullish or bearish story.

During the time the economy was the strongest, the Fed pointed to the unemployment rate being elevated as a reason for QE 1, 2, and 3 and ZIRP. This is mistake because unemployment is a lagging indicator. Firms fire workers only after their margins shrink and firms don’t start hiring again until the economy has been growing for a few quarters and shows sustainability. Any objective economist can see that the economy in 2016 is the weakest it has been since the financial crisis even as unemployment is low. Now the Fed has decided low unemployment is not a good enough reason to raise rates. The reason why the Fed changes the narrative as far as what data it looks at is because it wants to keep rates low regardless of the data.

This bad economic data plays into the Fed’s hands because the Fed always wants to maintain dovish policy. This understanding is what sets my projections apart from the mainstream economists. They themselves play into the Fed’s hands by taking some of their statements at face value and looking at what would be good policy. The Fed has no concern with what is good policy. It wants to maintain the bubble economy as long as possible. We know this because the Fed has proposed buying stocks and Yellen has said stocks aren’t in a bubble even though valuations are near all-time highs.

This brings us to the problem I laid out earlier. The Fed doesn’t want to raise rates in December because it saw what happened last December. Stocks were crashing early this year and only bottomed when global central bank’s coordinated extremely dovish policy. Given that the Fed doesn’t want to raise rates, having the chances of a rate hike be so high is a problem. Objective economic data signals the time for a rate hike has passed, but it can’t give off that vibe because then rate hikes in 2017 are also off the table and the market will foresee a recession with the Fed having no ability to cut rates.

The Fed is hoping for a one-off bad October or November jobs report, so the chances of a rate hike can be lowered without it making a statement. Then it can acknowledge the bad report puts off a rate hike. I described a bad jobs report as one-off, but it wouldn’t be that surprising to see a bad report as the trend has been towards weakness as you can see below.

jobs

Because there are two reports before the December Fed meeting, if either one is bad, the Fed can put off rate hikes by saying the situation is uncertain. The Fed wants to avoid making bold pronouncements in the November meeting as it is right before the election and before the jobs report. This won’t be difficult because it isn’t a meeting associated with a summary of economic projections and a press conference by the chair. The October report will be politicized. I think the Fed wants to say as little as possible about it as well. However, if it is really bad the Fed may have to make a dovish statement to quell the market.

After the election, the Fed can start commenting on the October jobs report if it is weak to portray dovishness. If it is strong, the Fed will have to hope for a weak December report. If that report is also strong (over 150,000) and the market is near its highs, the Fed will be forced into a rate hike it doesn’t want to do, just like what happened last December. The Fed knows a rate hike in December is risky policy, so it will make sure to put highly dovish language in the statement. It may rule out rate hikes for the next 6 months and talk more about buying stocks.

Conclusion

My predictions on Fed policies are predicated on the belief that the Fed really doesn’t want to raise rates. My support for this belief is the fact that the Fed never ended the so called “emergency policies” even after the recession ended. The posturing for the election to support Hillary Clinton may force the Fed to act in December. Because I think a rate hike would be paired with dovish language, buying gold would be a smart idea when the chances of a rate hike are high and gold sells off. Gold usually sells off on rate hikes, but when the Fed rules out future rate hikes for some time, it will rally. Gold rallied after the last rate hike because the market forced the Fed’s hand by selling off. If the Fed preempts this sell off, it could cause gold to rally and stocks to sell off less than last time.

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1 Comment

  • Piet

    October 26, 2016

    better the devil u know i wish the election is finish because the markets are like boiling water we need stability and i dont c that comming with both the bad news contenders