“That’s a risk that we live with every day and we’re going to live with that every day for many, many years to come, so I think you can’t be on pins and needles and say I’m not going to pursue the right policy for the U.S. because something bad might happen in that situation.”
That’s from St. Louis Fed chief James Bullard and one wonders where that rhetoric was last September when the FOMC did exactly that: they used the turmoil in China to justify holding off on the first rate hike in nearly a decade. Bullard was in Singapore on Thursday delivering the same speech he delivered in Beijing earlier this week. He joins a chorus of Fed speakers who have all but promised to deliver another rate hike by the end of the summer.
I, like many of you I’m sure, am sick to death of the debate around when the Fed will move next. The FOMC has become so obsessed with getting it “right” when it comes to communicating with the market and telegraphing their next move that they don’t seem to know when it would be best to just stop talking.
This is complicated immeasurably by how interconnected global markets have become.
Every speech is parsed for the slightest clue about the trajectory of the elusive tightening cycle and thanks to heightened interdependence, anything traders think they divined from needlessly incessant Fedspeak reverberates across the planet causing FX volatility and wild gyrations in asset prices.
I would argue that this is going to likely become more pronounced the longer they wait. No one is arguing that the US economy is running along at some swift pace. However, if the data coming out of the BLS even remotely resembles the reality of the jobs market in the US, then it’s probably safe to say that the economy would be fine with 25 more bps or even 50 more.
But that’s not what they’re worried about. They’re worried about asset prices and the knock-on effect a soaring dollar would have on EM. In other words: they are slaves to the market.
I bring this up for the umpteenth time today because as I was re-reading a Deutsche Bank note out late last week, I couldn’t help chuckle at the language the bank uses. It’s been a standing joke for some time now that the FOMC cares more about how Wall Street is doing than how Main Street is doing. But now apparently, banks have become so confident that what they say matters more than what the economy is saying that they’re just flat out making demands of the Fed. Here’s the most amusing excerpt:
“Dear Fed: Take just one step at a time and say you don’t know the destination.”
That sounds like a safe plan, right? Deutsche Bank just told the Fed to put on a blindfold and stumble along from live meeting to live meeting without any idea of where they ultimately want to end up in terms of rates. Here’s what else the bank had to say:
“While we stood apart from those expecting no hikes in 2016, apart from those expecting a recession as well as those who felt the Fed simply wanted more inflation and further declines in the dollar (G20 Shanghai coordinated global reflation), we have also been critical of the Fed’s dot plot and its suggestion of hikes every other FOMC meeting for 2+ years. We think each hike this cycle must be taken one at a time with no presumption of the future pace or final destination. The real neutral FF rate is uncertain and where inflation will be in future years is also uncertain. If the Fed lowers its future hike forecasts (or lowers the bottom of the range) it is unlikely that fixed income, FX, commodity or equity markets would act adversely to a hike this summer in our view.”
Ok, so two things there. First, it’s convoluted as it can be in keeping with most things Fed-related these days and the reason it has to be so convoluted is precisely because the Fed’s own reaction function has become a bewildering and increasingly long list of exogenous and endogenous factors which in many cases send conflicting signals about what should be done. Second, if not being able to predict the future with 100% certainty was a good reason not to make plans, then no one would ever do anything. Besides, until now all anyone wanted was clarity on the future course of policy. Now, Wall Street is telling the Fed to throw up its hands and admit it has no idea.
And the demands continue from there. Here’s another one:
“A summer hike is fine, provided Fed doesn't hike again until December at the earliest.”
Then, hilariously, Deutsche says the June statement needs to be accompanied by “clearer communication.” That comes just a few paragraphs after they suggest the Fed shouldn’t communicate at all!
“We do think the June FOMC decision warrants some caution and more importantly should be accompanied by clearer communication on an even more cautious future path, this should help align Fed dot-plot & market expectations and avoid negative shocks in the future.”
Of course you can’t really blame Wall Street for printing “insights” like those excerpted above considering what they’ve got to go on. The Fed’s Jerome Powell for instance, was out with the following helpful commentary just a few hours ago:
“Plan for gradual increase is best chance to continue to make up lost ground, [and] 2nd rate increase may be appropriate fairly soon depending on data and how risks evolve.”
“U.S. ‘at risk’ of reduced output, growth rate due to last recession; ‘goes without saying’ that policy makers should “use all available tools” to minimize supply-side damage from crisis.”
“Baseline expectation is that U.S. economy will continue to grow ~2%; “important” to see significantly stronger 2Q. Good reasons to think underlying growth is stronger than recent readings indicate.”
There’s more, but you get the idea. Those three quotes roughly translate to this: “Raising rates is the best way to raise rates and the data isn’t really good but it’s probably better than it looks.”
He’s just talking in circles, which leads directly to analysts doing the same thing.
Here’s Deutsche’s takeaway for equities:
“Historically the US economy performed its best and stock PEs were high when real GDP exceeded inflation by ~1.6x.
“The S&P PE is usually 16-18 when inflation was stable at 2-4%. We think the PE inflation sweet spot today is 1-3%, supporting an 18-20 PE on normal EPS provided 10yr Treasury yields do not exceed 3% or 10yr TIPS 1%.”
In other words, in an environment characterized by subdued growth, policymakers have to be careful with inflation - or at least if they want PE multiples to expand.
And as all of the above makes clear, PE multiples (i.e. stocks) are all anyone cares about. Just the way Wall Street likes it.
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