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This Is The Biggest Paradox Facing The Fed Ahead Of Its Rate Hike Decision
Ahead of today's FOMC announcement, which comes without a press conference and has thus been dismissed as a possible start to a Fed hiking cycle, the Fed has a big problem. It's not jobs, which are running at a pace that many suggest is strong enough to sustain at least a 25 bps hike to nearly a decade of ZIRP, assuming of course one completely ignores the "quality" component as virtually all recent job growth has been in the low-paying job category especially waiters and bartenders...

... but inflation, and specifically the bifurcation between core inflation and headline inflation.
Here is the paradox as succinctly summarized by Deutsche Bank, which notes that the current -29% year-over-year drop in the CRB index implies YoY headline CPI inflation falling from 0.1% to -0.9% over the next couple of months, or just in time for the September or December FOMC meetings both proposed as the "lift off" date. This would be the largest year-over-year drop since September 2009 (-1.3%) and one of the lowest prints in modern history.
However core YoY CPI inflation is likely to edge above 2% in the months ahead which complicates matters.
In other words, Fed will have to pound the table on the commodity crunch being a transitory event, just like every other "transitory event" that forced the Fed to postpone hiking rates since 2011. The problem, however, is that unlike "snow in the winter", plunging oil and commodity prices are proving to be anything but "transitory", and are mostly a function of China's economy whose ongoing decline is also anything but a one-time event. In fact, if anything, China's contraction is accelerating, with the recent bursting of its stock market bubble only likely to add to its headaches and to commodity price downside as Chinese Commodity Financing Deals are unwound.
Which brings us to the WSJ's Fed mouthpiece, Jon Hilsenrath, who largely summarized the above in his preview of what the Fed will today as follows:
The Federal Reserve has framed its decision about raising interest rates around the progress it sees in achieving its dual mandate goals of maximum employment and 2% inflation. Officials could emerge from their policy meeting today with a split decision – progress on the employment side of their mandate and continued uncertainty on the inflation side.
Fed Chairwoman Janet Yellen said in testimony to Congress earlier this month that the economy is “demonstrably closer” to reaching the Fed’s full employment goal. Since the Fed last met in June, the jobless rate has notched down further from 5.5% to 5.3%, its lowest level since April 2008, hiring appears to have returned to a path of steady gains in excess of 200,000 per month after stumbling in March and wages show tentative signs of moving higher. Fed officials will need to acknowledge these advances in their post-meeting policy statement, a sign that a rate increase is approaching.
Still it is hard to see how officials derive great confidence that inflation is surely returning to their 2% goal. Oil prices and commodities more broadly have resumed their march down and the dollar its movement higher, factors that have weighed on inflation all year. The Fed has described these developments as transitory before, but slow growth in China could give them some pause about that conclusion. Broad measures of inflation show little sign of breaking out of the sub-2% trend which has been in place for more than three years. Meantime, inflation compensation in bond markets has notched lower after stabilizing earlier this year. And though wages show signs of picking up, a breakout isn’t yet obvious and the links between wages and broader inflation are tentative.
Hilsenrath's conclusion: "It potentially sets up the Fed and markets for a cliffhanger policy meeting in September. The jobs part of their mandate – so important to Ms. Yellen – is signaling a rate increase is due. But the inflation part of the mandate signals continued patience. Officials won’t want to lock themselves in until they see more data on the economy’s performance."
Which is probably another way of saying what Lloyd Blankfein just stated in a Bloomberg TV interview, namely that the "first rate hike will be jarring."
And while the above covers the Fed's thinking on input drivers, but what about the market's "reaction function" manifesting in the strength of the USD? Here are some thoughts from UBS on the topic:
The dollar's strong foreign exchange value remains a challenge for forecasters and investors. Over the year ended in June, the Federal Reserve's broad trade-weighted dollar index rose 12.5%. (The major currencies component was up 17.3% and the other important trading partners component rose 9.0%.) How much difference does a strong dollar make for Federal Reserve monetary policy and the US economy? Our answer is that a strong dollar means growth and inflation are lower than they would be otherwise but probably not by enough to preclude the Fed funds rate tightening that we still see beginning before year-end.
One way to assess what a strong dollar means for Fed policy and the economy is to consider some recent analyses provided by Fed economists for Fed policymakers. One such analysis comes from Federal Reserve Bank of New York economists Mary Amiti and Tyler Bodine-Smith in a July 17 Liberty Street Economics article titled "The Effect of the Strong Dollar on US Growth". They concluded that sustained 10% dollar appreciation after a year reduces US real net exports enough to subtract 50 basis points from US real GDP growth, with another 20 basis points coming after the second year. (See Figure 1.) These effects are more related to lower exports, which are more sensitive to dollar movements than imports.
If the strong dollar makes near-term real GDP growth 50 basis points lower than it would be otherwise, would that be enough to preclude a Fed funds rate hike before year-end? That might be the case if the Fed only considered actual versus its expected real GDP growth. For instance, in the FOMC's mid-year projections of Q4/Q4 real GDP growth, the members' central tendency forecast was 1.8% to 2.0% for 2015 and 2.4% to 2.7% for 2016. Heading into 2015, Q4/Q4 real GDP growth at the end of 2014 was 2.4%. A 50-basis-point reduction in growth due to a strong dollar would still leave growth at the 1.9% mid-point of the 2015 central tendency forecast if growth momentum outside of the trade sector is maintained in 2015. Clearly, given the uncertainties about how much a strong dollar reduces growth, it is a close call whether the strong dollar over the past year will enable the Fed to achieve its growth targets.
However, the Fed is more likely to be influenced by the unemployment rate and core inflation than real GDP growth. Frequent and uncertain revisions to real GDP growth are a practical reason for the Fed not to hitch its Fed funds rate and balance sheet policies to published real GDP growth. While the unemployment rate and core inflation inevitably are imperfect measures, at least they are not subject to the types of sometimes large revisions associated with real GDP growth data.
So maybe the resumed strength in the dollar won't be enough to push the Fed away from the hike button, but it surely will be enough to crush corporate sales and EPS, as has been the case for the past two quarters and will be for the coming quarters. Recall that the biggest complaint by far during Q2 the earnings season by CFOs has been the strength in tthe USD. How long until the CEOs of US multinationals decide to all dial the Fed and make it clear that the ongoing surge in the DXY will simply not do?
What does the Fed likely do? Nothing today, almost certainly nothing in September, and a small rate hike in December just to show it can is possible. The question then is will this send the dollar surging even more, and lead to an even more acute crash in corporate profitability, one which not even buybacks and non-GAAP addbacks can mask the underlying corporate recession, and more importantly, just how much more credibility can the Fed afford to lose as a result of the recent dramatic flattening in the yield curve, before we finally get the clearest recession signal of all, a curve inversion, at which point the next step after the rate hike becomes inevitable: even more QE?
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Call me big daddy when you back your ass up
But pouring a scotch on the rocks IS manufacturing
Raising interest rates from nothing to nearly nothing?
lol
Optics. Totally meaningless in the Quantitative Easing/Tightening paradigm.
Wake me when US.gov stops stealth QE like holding down oil prices by selling strategic oil reserves on the open market, replacing inventory by buying oil directly - off the market - and then making up the accounting loss with money printing.
Blah, blah, blah blah.......... Did you BTFD?
Like buying up all the student loans, home loans, car loans, bank fuckups.
Send in the clowns, there ought to be clowns.
That pesky real world refuses to conform to the FED's super awesome model of never-never land. They are now talking about a mere 10 bps rise...someday......
Oh you are right that it is "nearly nothing"...
But just what will a 25 Basis Point hike do?
We know that there are roughly $555 Trillion in DERIVATIVES that are tied to the Ten Year Note.
So what will that 25 Basis Point Rate cost?
Hmmm...Let's see...
A full percentage rate hike would be $5.5 Trillion.
And a Quarter of that would be in the neighborhood of..oh...gee...can that be $1.4 Trillion? (Don't have my gonkcuilator handy at the moment...)
Yeah. No worries whatsoever. That just amounts to a WHOPPING 9% of GDP.
No worries whatsoever.
If Janet raises the rates then she will CRATER THE ECONOMY...and SHE WILL LOSE CREDIBILITY.
If Janet does not raise the rates then everyone will know that the Emperor has No Clothes and LOSE CONFIDENCE...So SHE WILL LOSE CREDIBILITY.
See...You are right. Why make so much out of nothing? The end result is the same.
Assuming that all derivatives contracts would go to $0 seems idiotic to me.
I am not making that assumption at all. I figure that the long and short side of the trades will still be zero sum.
But for the actual parties who hold those derivatives, an Interest Rate Hike will cost them...large.
No bout a doubt it, I once said while under the influence. But a slight uptick in short-term rates does not mean the 10-year will follow suit. The yield curve could ever so slightly flatten.
buying a woman a Scotch on the Rocks is manufacturing consent.
Agree. Just call them "adult beverage assemblers" and "food delivery logistics engineers" and reclassify both as a manufacturing job. Done.
I don't even see how anyone could find this the slightest bit complicated. I'm amazed they haven't done it already.
Two-bit whores are now called low-cost providers.
High-class whores are still known as politicians.
See, HH gets it. How difficult is this?
These careers now require a masters and bachelors degree + lean six sigma training certificate.
But pouring a scotch on the rocks IS manufacturing
no, on a shitty blend such jack daniels, it's pop culture gesture.
on a respectable single malt, it is the most fubar gest possible, especially against irish factories.
That was neat
VXX breakout?
But there was also a HUGE uptick in transgender reality television show hosts so we've got that going for us.
Did Obama find his birth cert buried under a hut in Kenya yet?
Fuck all the fake inflation data from Deutsche Bank - real inflation is 7 to 10% higher than the official estimates:
implies YoY headline inflation falling from 0.1% to -0.9% over the next couple of months,
Here are the real inflation numbers and the corresponding GDPs:
Let's not forget that US inflation numbers are completely fake - so real US GDP is much, much lower:
The Chapwood Index for 2014 was 9.7% and official CPI in the land of the free was only 0.8%. So the Nominal GDP of 5.6% for 2014 becomes real GDP of -4.1%.
The revised real GDP for years 2011 to 2013 worked out to -6.2%, -6.5%, -6.5% respectively.
What is the Chapwood Index?
"The Chapwood Index reflects the true cost-of-living increase in America. Updated and released twice a year, it reports the unadjusted actual cost and price fluctuation of the top 500 items on which Americans spend their after-tax dollars in the 50 largest cities in the nation."
http://www.zerohedge.com/news/2015-05-29/inaccurate-statistics-and-threa...
Odd nobody points to the nexus of all the falling demand...slowing population growth and its breakdown but everyone recognizes the debt incurred to hide the slowing demand.
http://econimica.blogspot.com/2015/07/federal-reserves-therapy-has-nothing-to.html
The Fed and all CB's are powerless against this and yet won't even acknowledge where our troubles start or why their printing could never work to truly restart the economy.
The "PAINT INDEX" confirms what we all know...there is inflation, insidious inflation when they sell a GALLON of paint with a GALLON on the label only containing 116 ounces instead of 128...Give me a F*&(&ing Break!!
http://consumerist.com/2008/08/11/dear-lowes-a-gallon-has-128-fluid-ounc...
If I didn't know any better, I'd say that looks like Bald-Faced FRAUD to me. There ~has~ to be some sort of legal loophole for them to be able to get away with this, no...?
Actually, this is done in many venues. The actual sale is for paint in a 1 gal container. Much like draft beer at a resturaunt; you buy a 22 oz beer but only get 16 oz. of beer and 6oz. of head space and foam. But you did receive it in a 22 oz. glass.
Now subtract government consumption which is counted as production and what do you get?
"Do not try and raise the rate. There is no rate." - Spoon bending boy.
imo, they will never raise rates even when it crashes and burns
"It potentially sets up the Fed and markets for a cliffhanger policy meeting in September. The jobs part of their mandate – so important to Ms. Yellen – is signaling a rate increase is due. But the inflation part of the mandate signals continued patience. Officials won’t want to lock themselves in until they see more data on the economy’s performance."
~ No "cliffhanger" in my mind...Rates will not be raised!
Painted deeply into the corner.
All this angst over a stinking .25 point. Does anybody really believe we will ever see fed funds above 1% again? Anybody? Crickets.........
I'm going to recuse myself from answering that question.
Lol.... That juicy steak sounds better every day now doesn't it?
Yeah but if it ever does get that stinking .25 points you can be sure that it will signal a PM manipulated crash.
Rate hikes will blow up the US gov't deficits. They haven't updated the debt tally since the early spring, leaving it at 18.3 T for all these months.
I doubt there will be any rate hikes. How long will they keep crying 'wolf!' ?
Voters keep re-electing the same assholes to Congress. Both parties. Time to clean house in Washington D.C. and cut government. How about starting with 20 years of surplus to reduce the outstanding debt?
Who cares. If we have learned anything, it is that the Fed loves being in the spotlight and they love the bubbles they create that make them popular. If you wanted a giant asset bubble, zero rates for a decade sure would do the trick. That is the only reason rates have been so low. They want asset prices to be nosebleed high to make the debt look reasonable and prevent a deleveraging. It has nothing to do with employment or inflation. If so, they would have raised rates long ago as employment has recovered and inflation is and has been positive, even under the PCE which understates it by design.
Asset prices will, and can roll over on their own. The Fed needs to have a longer view, rather than trying to prick localized bubbles which are, at best, transitory in nature. The tech bubble and the new housing bubble appear to be rolling over as it stands.
I truly can't take this shit anymore! I'm seriously close to cashing in the 401K, checking account, all of it and living in a cabin somewhere 50 miles from anywhere....
I've had it!
Youdaman!
Don't forget the truckload of tinned herring (in water) and nitrogen packed rice when you bug out.
The snake is eating it's own tail and has run out of tail.
Is now looking for other snake heads to eat.
It's either a series of fractional-mini hikes or the constant delays on a regular basis are part of a bigger scam that things are a lot worse than they want the public to know right now.
Am I the only one who thinks it is completely idiotic to view inflation in terms of 1 quarter or 1 year. The average trend of prices over several years relative to wages is all that matters.
Plus, the Fed seems to have made 2% inflation per year minimum the goal. So, if we have 5% inflation one year and 1% the next, they claim they are undershooting. Such BS and clearly not meeting the price stability mandate over time.
phony employment thresholds, phony inflation thresholds, drop one pick up another, kick the fed policy can down the road
It's idiotic to try to spot trends quarter-to-quarter. But that's short-term thinking for you.
everyone have your Yellenburger at 2pm and stfu
Kosher pickles with that, sir...?
This policy decision or that ... raise rates or not ... to a layman like me, I believe that all Fed moves are like the moves in the game Jenga. Sure, the rules say to avoid the tower falling, but everyone knows the tower is supposed to fall — that's the enjoyment to the players of the game. The Fed knows the tower is falling; their enjoyment comes from knowing they will own all the blocks when it does.
I still can't believe our government, who has the power to coin money and thus avoid interest payments, still pays a middleman to do their job.
i think the feds plan is to sit in the background and let the banks set interest rates. whatever happens they will follow their lead. this is the last ditch of credibility, let the markets set the rates, but don't tell anyone that is your real policy, that gives the discovery mechanism time to work. the fed is one crisis from a balance sheet meltdown. the global plan is to replace the dollar with gold backed SDRs, so the value of the dollar is inconsequential. the drop in global commodities might be signaling this, since the EMs (commodity export countries) are lacking in gold reserves. this rate hike is nothing in the greater picture.
Core inflation is likely overstated, especially with so much of the economy falling off a cliff. The Fed needs to stand at zero, and commit to such a stance at least for an additional few years. The economy simply cannot withstand higher interest rates without precipitating some sort of deflationary crisis.
Markets and financial media expect a rate hike and that's why Janet Yellen is getting everybody ready for rate hike. It's as simple as that. Fed wants to create the illusion that it's in control and that the recovery is coming along and that the economy will continue to recover at it's first rate hike in many years. The rate increase will likely be tiny. It's really out of institutional pride as Jim Grant put it. Difference is, I don't think Fed is seriously going to raise interest rates that high. More like tiny move. Janet Yellen is most likely going to follow the Greenspan playbook of incrementally raising interest rates very slowly (even slower than Greenspan) and see if a drop off in recovery occurs before reducing rates again and/or launching another QE.
Janet Yellen even hinted as tiny rate increases, not a size-able increase in rates.