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This Is The Fed's "Second Biggest Nightmare" According To Citigroup
Two weeks ago, Citigroup presented what it thinks is the biggest nightmare for the Fed: it said that the FOMC’s "biggest worry is not lift off and its market and economic implications, but what happens if the economic recovery dies of old age without the Fed having done anything to tighten." And, according to Citi's FX strategists, "if this were to occur, the USD would probably fall faster than it rose from July-March." A precursor to loss of faith in the Dollar's reserve currency status perhaps.
Today, Citi's Steven Englander lays out what is the Fed's second biggest nightmare: a rebound which is so fast, the Fed's entire carefully planned renormalization schedule collapses.
Some further details:
Based on current trends we will be at zero unemployment before we are at 2% inflation (Figure 1). This is unlikely, even if you are a dedicated trend follower, so we have to decide which trend will bend first. It’s tempting to say that the unemployment trend will bend first because going to zero unemployment is a bit like breaking the speed of light. Paraphrasing Herbert Stein, if two trends are incompatible, they will collide, it will turn. However, it is quite plausible that unemployment is will keep on trend long enough for inflation to turn up. Moreover, given the strong employment bounceback that so far is not matched on the demand side, we could get a third quarter in a row of negative productivity and stunning unit labor cost numbers. This note examines the implications for asset markets and the USD of the Fed getting to its inflation targets quicker than the trends in Figure 1 and money market pricing would suggest.
We argue that the Fed's second biggest nightmare is discovering that they have hit both employment and inflation targets quicker than the market now prices in. The implication would be that they would have to get to neutral policy rates faster than they or the market now expect. That would be disruptive to asset markets, leading to much higher volatility and very likely to lower returns. It would also concern the Fed since it is much harder to calibrate an abrupt move in policy rates than the slow and gentle that they hope to achieve.
Today's sudden, jerky moves in the 10Y confirmed just that when the jobs number came in substantially hotter than consensus expected, leading to a dramatic and quite volatile sell off in both bond and equities, even if the initial dump has been stabilized.
So what happens to asset markers in this "nightmare" scenario? This is how Citi views the long-term FX reaction:
A quicker tightening and steeper lift-off is more USD positive in the short term than in the long term. The ‘inflation rises faster than expected’ scenario that we are discussing also means that slack diminishes more rapidly than expected. That gives us the faster path of rate hikes and the stronger USD. We suspect that USD will rise much quicker in the weak potential scenario (once the short-term risk concerns mentioned above) subside. So little inflation is expected that the flat line trend in Figure 1 is probably not very far off expectations for core inflation. Any pickup in inflation will come as a major surprise and as a jolt to the very flat pace of hikes that is expected.
But we suspect the USD cycle will be curtailed as soon as it becomes clear that rates will peak sooner and lower. However, if we are eliminating slack because potential growth is slower, then the terminal policy rate will likely be lower as well, reflecting lower returns to capital. This is shown schematically in Figure 5. The light blue line shows a hypothetical policy path when potential growth is low. The policy path is steeper because there is less slack at each moment in time, but it tops off at a lower level because slower potential growth is likely to mean a lower equilibrium rate. We are assuming similar paths of demand growth in both scenarios so the narrowing output gap reflects diminished potential rather than weak demand. Once the Fed indicates that it thinks it has tightened enough to prevent inflation from rising or the economy shows clear signs of slowing, we think USD selling pressures will quickly emerge.
Both the Fed and foreign investors will worry that the room for easing via conventional rate reductions is limited and that the zero bound will be rapidly hit on any slowdown. Once additional probability weight is added to dealing with the zero bound, the set of asset market moves associated with QE and liquidity additions becomes operational. So we could transition rapidly from a conventional rate normalizing Fed hiking cycle to concerns about hitting the zero bound again.
The conclusion:
In an ideal world, as we approach full employment and full capacity, the pace of growth would slow so that capacity does not keep tightening once we hit full capacity. If you wanted the economy to ‘run hot’ you would aim for output stabilizing slightly above full capacity, so that there is gentle upward pressure on inflation. You would not want to be moving even further beyond full capacity because that would add to inflationary pressures that would increase the degree of subsequent tightening.
So any indication of a pickup in core inflation would be viewed by FX investors as solidifying and steepening the rates path, which would feed into USD strength. If the equilibrium policy rate moved up in consequence, that would add to USD pressure. The realization that the economy is running hot could lead to a reassessment of how much stimulus was actually in place. Nevertheless, it is sufficient that the market accelerates its expectations of rate hikes for the USD to spike up.
And while all of the above makes sense, there is a far bigger problem: if and when the market realizes that the Fed has overshot its mandate, what happens then will be the most epic, one-way and illiquid dumping of bonds ever. This is how another Citi strategist, Matt King, saw that particular event taking place:
Central bank distortions have forced investors into positions they would not have held otherwise, and forced them to be the ‘same way round’ to a much greater extent than previously. The post-crisis increase in correlations, which has been visible both within credit and equities and across asset classes (Figure 35), stems directly from the fact that investors now increasingly find themselves focused on the same thing: central bank liquidity. Every so often, when they start to doubt their convictions, they find that the clearing price for risk as they try to reverse positions is nowhere near where they’d expected.
This explains why the air pockets have not just been in markets where the street acts as a warehouser of risk. It explains why they have occurred not only in the form of sell-offs which could have caused multiple market participants to suffer from procyclical capital squeezes. It also explains why the catalysts have often, while often trivially small, have nevertheless been macro in nature, since they have boosted expectations of a change in central banks’ support for markets.
Unfortunately, it leads to a rather ominous conclusion. The bouts of illiquidity will continue until central banks stop distorting markets. If anything, they seem likely to intensify: unless fundamentals move so as to justify current valuations, when central banks move towards the exit, investors will too.
Rather than dismissing recent episodes as relatively harmless, then, we are supposed to worry how much larger a move could occur in response to a more obvious stimulus. While financial sector leverage has fallen, debt across the nonfinancial sectors of almost every economy remains close to record highs, meaning that the potential for negative wealth effects in the real economy is very much there.
In principle, markets could gap to a point where they went from being absurdly expensive to being absurdly cheap, and then – as investors stepped in again – gap tighter, perhaps even without very much trading. But the existence of the feedback loop to the real economy means that the fundamentals tend also to be affected by extreme market moves: “cheap” may be a moving target. This in turn could force central banks to step back in again.
To sum up, we are left with a paradox. Markets are liquid when they work both ways. Market participants, though, find themselves increasingly needing to move the same way. This is not only because of procyclical regulation; it is also because central banks have become a far larger driver of markets than was true in the past. The more liquidity the central banks add, the more they disrupt the natural heterogeneity of the market. On the way in, it has mostly proved possible to accommodate this, as investors have moved gradually, and their purchases have been offset by new issuance. The way out may not prove so easy; indeed, we are not sure there is any way out at all.
"No way out at all" indeed, which is why yesterday we also wished the Fed, which is now completely trapped, the best of luck with the whole exit thing.
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Let me hip you to something folks, they plan to collapse the banking system entirely...
Out of the ashes will arise the Pheonix, that is to say the Digital Banking System they have...
It will be the ONLY option, because of taxes all money in circulation will eventually return to issuer...
As quack as that idea may sound, I'd venture to say they are willing to use force in order to get people to comply....
(I mean if they'll bomb countries who wanted to go off the Dollar, what more will they do to us? They are after all just heartless criminals.)
There is no recovery.
It is a scam.
Remember these:
http://www.zerohedge.com/news/2015-06-03/why-did-these-former-fed-members-admit-mathematically-logically-reality-its-over
http://www.zerohedge.com/news/2015-06-03/much-bigger-threat-our-national-debt
These guys are thinking too hard. When the fed "overshoots their mandate" they will just find a new mandate.
Regards,
Cooter
Rather than finding a new "mandate" we should be demanding a new Fed.
One not privately owned and manned by criminals preferably...
the evil of the fed manifests itself in several ways the most
insidious is the brutally punishing way it devalues savings
through money printing at a rate far exceeding any rate of
return possible. the fed steals silently.
the system called federal:
to enslave a free people to dept, and capture all assets through
boom and bust, with money printed out of thin air.
100 years, truly mission accomplished.
We should not be planning a new FED, we should be planning life after the FED.
We're turning Japanese. We think we are turning Japanese. We really think so.
https://www.youtube.com/watch?v=IWWwM2wwMww
It's very clear that they simply want to use the Fed's rate tightening as a cover for more outright economic theft by monied elites, which will be called a "downturn."
CitiBanksters will all be remembered by the Guillotine.
Jump now fuckers, and pay your homage to your makers.
Have a listen here if you think America isn't completely finished...
https://www.youtube.com/watch?v=0Dl1liXlWYc
(Yes, they are making power moves against America & the Fed, that is for certain, and they WILL collapse the banks to usher in digital currency, period.)
With mandatory digital currency and paper currency outlawed there will be a run on Tide, toilet paper and other marketable commodities for barter. There will be shortages of retail itens for everyone. Cigarettes, pharmecuticals, booze, psychedelics et all will go to the highest bidders.
your neighbors left leg, that stray dog, any fresh meat will be marketable as will sexual, perverted masochistic and other services. Use your immagination.
Really the Citigroup statement is based on the assumption that the employment numbers and cost of labor numbers are accurate, we know they are not.
and they said we are "going the way of rome".
finally, a visual explanation of how the fed works that's easy to understand:
https://i.imgur.com/iu3oO5J.jpg
I wonder if they used the LHC at CERN to figure that out...?
They may do this domestically, but the US is quickly fading on the global scene. Gunboat diplomacy works great when you are knuckling one despot at a time - all of them at once, not so much.
If the new "silk road" takes hold and trade in Eurasia establishes itself primarily by land (roads, energy pipelines, electricity transmission corridors, etc) then the US is pushed away from the table unless they plan to invade with lots and lots of boots.
Obama may just seal the deal, given his Chicago style of gangster leadership when dealing with other sovereigns.
Regards,
Cooter
The fact that the creator of silk road (a truly free market), basically a programmer, was sentenced to life in prison while the likes of Joh Corzine walks free, should tell everyone just how desparate the oligarchs are.
Different silk road. I am talking about the establishment of trade routes between Europe, Russia, the Mediteranian, and the Asian side with China, India, etc.
http://www.zerohedge.com/news/2015-05-27/new-silk-road-part-2-cold-war-o...
Regards,
Cooter
Good luck with that. Moral hazard and exponential equations are a real motherfucker, so unless they plan on nuking several billion people, "forcing" 7+ billion to accept digital bullshit (especially the energy producers) will be impossible.
you are here--> when fraud is the status quo possession is the law.
You dont need force, all you need are new plastic cards with cute pictures on them.
You can give them away since they dont cost you anything but an account entry and some cheap hardware.
Instead of getting Credit Cards in the mail youll get New World Cedits. Large banks will issue them all they ask for in return is that you open an account free of charge of course. All will be welcome no fees no cost just lots and lots of personal data.
So how much credit will it take for you to sign up. 1000, 2000 or as little as 50 bills in local currency. Just remember this credit is only useable at these fine retalers.
Good so all our contractual obligations valued or based on in US dollar payments goes up in smoke with it, debt free bitches.
WHERE are these "stunning labour cost numbers" coming from...?
Someone is actually RAISING salaries in this economic climate? Where is the final demand? Who are their customers?
Executives appear to be doing just swell.
Absolutely! There is a huuge gap between real workers abilites and their salaries now, just because of the "easy money". There is a hidden inflation in the labour salaries too..
Absolutely! There is a huuge gap between real workers abilites and their salaries now, just because of the "easy money". There is a hidden inflation in the labour salaries too..
"...a rebound which is so fast, the Fed's entire Plan 9 from Outer Space collapses."
fixed it.
Bowing my head... One of the greatest movie making pursuits ever put to film.
"Two weeks ago, Citigroup presented what it thinks is the biggest nightmare for the Fed: it said that the FOMC’s "biggest worry is not lift off and its market and economic implications, but what happens if the economic recovery dies of old age without the Fed having done anything to tighten.""
It's no longer a worry. The only indicator that suggests the market is taking off is the one manipulated more than both the Inflation Rate and GDP. And that is saying something.
Pushing the theoretical limits of confidence does have its consequences.
Every Fed measure has been played out keeping the can kicked since 2008. IF, we go into serious recession while the Fed is fully engaged, what can they do then? Panic I suppose. Imagine a major recession with negative interest rates already in place! Yep! That is called be fucked before you start.
true except its all based on illusion, which is a nice way of sayng lies. Unemployment is at something like 20% and inflation is running between 8 and 10% so this entire pile of words is a bunch of toilet bowl deposit.
All of this crap about if/when the Fed is going to raise rates is analogous to Greece paying what it owes. Both parties can talk all they want, spread rumors, bluster and bloviate in order to push back and forstall the inevitable, but anyone with half a brain knows the truth; neither with EVER happen, period.
"...a rebound which is so fast ...
Ha Ha Ha, Thats a good one!
I struggled a bit with that until I substituted "hyperinflation" for "rebound"
Everything we have done so far is at best, a borderline failure. But what if this time, we succeed beyond our wildest dreams? Maybe we should plan for that...
And maybe they should pass around whatever it is that they are smokeing...
reading this just wasted 5 minute of my life I can never get back
i would have thought the Fed's biggest nightmare would be the sheeple of the US realize they've been fucked non stop for the last 15 years by the Fed and hung all fed members after horrendous torturing of the lying sacks of shit.
or is that my favorite dream?
Citigroup is walking dead. The putrid scent of disinformation is all they offer.
The only surprise here is that so few seem able to question the output of statistical models whose inputs are goal-seemed.
The unemployment number is a unicorn- an imaginary animal.
Like the Speed of Light real 0% employment is physically impossible.
The significance of zero unemployment (or negative) is that the subsequent reevaluation of definitions will underscore that Emperor Econ is naked, and all our currencies are his non-existent suit.
The only surprise here is that so few seem able to question the output of statistical models whose inputs are goal-seeked.
The unemployment number is a unicorn- an imaginary animal.
Like the Speed of Light real 0% employment is physically impossible.
The significance of zero unemployment (or negative) is that the subsequent reevaluation of definitions will underscore that Emperor Econ is naked, and all our currencies are his non-existent suit.
Not just goal-seeked, but Federally mandated goal-seeked.
There must be something very wrong, because Washington now started to talk about nukes again, even about preemptive strike against Russia (we could attack Russian missiles on the Russian soil)! I just have a very bad feeling that this might not be just a reset of markets but something much worse, reset of humanity maybe. But it also means that they are loosing control fast, when they now see using nukes as a solution. The USA is such a mighty military power (well, obviously NOT it seems!), so why are they so much afraid of Russia that they think they will have to use nukes and not just conventional forces??? Even if they really wanted to "reduce global population" - that could very well be done with conventional forces. But with nukes, they risk a nuclear winter - Armageddon - their own deaths as well!! Are they now officially braindead? This is all just totally crazy. I am talking now with people in EU here and we are really starting to be very fed up. People even talk about crashing the parliament (because it is pro-USA) and somebody proposed using a bulldozer:-) I know it is just talk, but blood pressures are rising, mind you many of these people here still naively thought the USA is our ally just few months ago, but somehow even the most anti-Russian people are changing opinion fast. But if anyone uses nukes, we are all dead. Russia has the Perimeter, which means total Armageddon, no limited destruction, no - just total end. Well, perhaps other creatures will get their chance now at this planet. Animals like insects and even rodents are able to survive radiation happily, like Chernobyl showed. This will be a planet of rats.
The biggest fear is that they have to explain swaps.
Not the transactions, but the benefactors.
Not to be picky but suspect you mean the beneficiaries.
You wanna raise the Employment of the REAL Middle Class? Stop replacing educated, experienced and productive American with low-cost H1B Visa imports, you dumb-ass politically-correct scumbags!
Since "Rewards dictate behaviors", use the Keep-Stop-Start principle to stop doing the wrong things, and start going back to doing the right things. This includes firing all the PC consultants to HR execs, who, for the most part, have become totally Litigation Paranoid and Bad Press Paranoid, which might affect their precious stock prices.
"Based on current trends we will be at zero unemployment before we are at 2% inflation"
Did someone forget their Bipolar meds this morning or is this another tongue in cheek post from Hilsratass.
We could easily be at 0 unemployment now. All the Fed would have to do is not count ALL of the unemployed, instead of just most of the unemployed.
Anybody quoting either CPI or unemployment numbers as they were fact needs to remove his head from his ass before speaking.
f*ck shitibank
Welcome to the roller coaster ride of the century!
"Strong employment bounceback"? This guy probably thinks the unemployment rate is 5.5% and price inflation is less than 2%. Gullibility has no limits.
.
BWAH HA HA HA HA HA HA !!!!
Yes, the explosive U.S. recovery is lurking just around the corner, ready to suddenly appear. Elvis and Jimmy Hoffa will present the data at a press conference...
But given how long the fuse has been burning in Japan, the only question is whether the recovery in Japan is too strong, Nuclear even, and gives rise to the creation of enormous reptilian mutant creatures...
WTF?! WTF?! WTF?!
I agree with Citi. I think the $usd is in for a big correction. With rates at the levels they are now, I think additional $usd gains will be very limited if the Fed. lifts rates or not.
As a matter of fact, I think rates will actually go down if the Fed. raises them as the equity markets sell off and people run to bonds. The $usd will follow suit as rates decline and investors pull out of equities.
The European and Asian carry traders will unwind their long $usd hedges with the yen and euro and the $usd will come under even more pressure.
As a matter of fact, I think rates will actually go down if the Fed. raises them as the equity markets sell off and people run to bonds.
From the FED's perspective this may be the best outcome; they get to save face ("we told you we would raise rates!") while minimising the negative effects on the housing market. The sticking point will be the pace of the equities sell-off, and that's what the PPT are for.
The European and Asian carry traders will unwind their long $usd hedges with the yen and euro and the $usd will come under even more pressure.
Isn't this is what Q€ and Jap-QE are designed to prevent?
The European and Japanese Qe programs are designed to hold interest rates down and push their respective banks to lend.
The banks instead invest the QE procedes in global equity markets and bonds, knowing they can achieve higher yields. When investors use $usd as a funding currency to buy European and Japanese assets they are short $usd when they exchange the dollars for euro or yen to purchase said assets.
Yes, they have to buy back those lent $usd when the trades become unprofitable, but they also have to convert those dollars back into the base currency they used to borrow the dollars, so it's a wash. (you're buying and selling $usd simultaneously)
Investors hedge their trades in the F/X market in order to avoid the the exchange rate loss. ( short eur/usd and long usd/jpy)
When those investments turn sour investors have to unwind those hedges. (reverse the trade =sell $usd)
The European and Japanese Qe programs are designed to hold interest rates down and push their respective banks to lend.
Sorry I shouldn't have used the word designed. What you say is indeed the stated purpose of these QE programs. As you point out, the actual effect is to depreciate the currencies via carry trades.
What I was trying to suggest is that USD may not depreciate as you expect in the raise rise scenario you had described.
PS Thanks for taking the time to so comprehensively answer.
If yields drop "fear trade", and the equity markets are selling off in tandem I'd find it difficult to be long the $usd.
The primary reason the $usd has been so strong is because of ZIRP and the "global decoupling" meme. I just don't see a compelling reason to be long $usd once the equities start correcting, and yields start falling.
I'd probably like to be long the commodity currencies, as everyone runs for hard assets.There a huge tranch of China macro next week, and the charts will look entirely different by the 12th. ;-)
Thanks for the kind comment.
If yields drop "fear trade", and the equity markets are selling off in tandem
I think this is the FED's nightmare scenario. If I had faith that they are able to achieve their ends (which depends a lot on whether you believe there's a plunge protection team or not) then I would be more optimistic than you on USD.
I agree 100% about a flight to hard assets, in any event. I believe the commodities crunch has created the necessary "slack in the system" to soak up the outflows from an equites or bonds decline.
The PPT scenario is a bit stretched at this point... The Fed. desperately wants to unwind it's balance sheet.
In 2008 the Fed. fronted European banks well over $ 1-T of liquidity, to keep the banking system together.
There's NO way the PPT has the resources to step in this time. I won't even go into "civil unrest" ramifications, if banks were bailed out again.
Even if, you're still facing massive inflation through devaluation.
I think if I was locked up in a tower and forced to create "analysis" like this I'd be jumping off buildings too.
No drug made by man can get these people this high, what are they taking?
This article is an undeniable indicator of how out of touch the elites are with the real world. To say that inflation is low and under control indicates that these pampered parasites either do not shop for food and other necessities or the costs are such a pittance compared to income that they don't notice prices, much less consistently increasing prices. I do hope that they enjoy their day in the sun while it lasts…
Looks like this is one cluster that won't un-.
As someone here once said -
The CBs of the world are masters at painting themselves into corners they themselves created...
So basically these morons think the Fed has a problem because of the supposed relationship between two lying series of government numbers, each of which is a work of fiction.
"Full employment". HAHAHAHAHAHAHAHAHA!!