Via Scotiabank's Guy Haselmann,
FOMC
For many, there is typically a large divide between what they believe the FOMC should do, and what it will actually do. There are those who believe the Fed should not hike until next year or later: they include Charles Evans, Narayana Kocherlakota, Jeffrey Gundlach and the IMF. Others believe the FOMC should have hiked already and should begin ASAP (even at the July meeting next week): those in this camp include, Esther George, Loretta Mester, Jeffrey Lacker and me.
- Neither outcome will likely happen, despite reasonable and easily understandable arguments for either delaying or advancing lift-off.
- Somehow the FOMC has veered back to its ‘hated’ calendar guidance, signifying the September meeting as most probable for lift-off.
It seems to me that the delay camp has too much faith in models. Inflation and economic slack and few other aspects that constitute the basis of their position, may not be as fully understood as they claim. Globalization, technological advances, and the drift in the US economy from a goods-producing to a services economy, has weakened economic forecasting accuracy and understanding.
Nonetheless, this camp wants to wait for certainty (that the Fed’s full-employment and inflation mandates are achieved) before hiking. They have little concern that official rates have been at the ‘emergency level’ of zero for six years; well past emergency conditions. They believe that overshooting is preferable to undershooting targets, because of asymmetry, i.e., it has the ability to hike rates, but does not have the ability to ease from zero (further QE is likely a political non-starter).
The delay camp also does not believe (rightly or wrongly) that there are any current (meaningful) risks to financial stability. Rather, this camp seems excessively more worried about having to reverse course after hiking.
I have outlined numerous reasons for over a year why the Fed should hike rates ASAP (including moral hazard, record levels of corporate issuance, impact on pensions and insurance companies, investor herd-trading, inequality, renewed sub-prime lending, and low-quality securitization) so I will not get into detail here.
Yellen said that the choice is hiking ‘sooner and slower’ or hiking ‘later and more aggressively’. Hiking sooner is more consistent with her preference and message of a gradual path toward ‘normalization’. She also said that a hike would indicate confidence in economic momentum; so wouldn’t an early hike rid markets of the uncertainty around the timing of the first hike as well as allow for a longer (i.e., more gradual) period before the second hike?
Bottom line.
The FOMC should stop dangling a rate hike over markets with its informationally-challenged term ‘data dependency’. Currently, financial conditions are ideal and economic conditions are plodding along with progress. Market interest rates are low. Spreads are tight. Equities are at, or near, all-time highs. The dollar index (DXY), while higher than last year, is 4% lower than where it was during the March meeting. China and Greece (and other geo-political flash points) are far from solved, but at the moment, there is relative calm.
Financial Markets
During the last week of April, I recommended being cautious on Treasuries (German Bunds were a catalyst). However, in May, after a steep selloff, I recommended re-establishing tactical longs in the backend (10’s and longer) in front of 2.40% yield on the 10-year. While chopping around ever since, the support levels of 2.40% 10’s and 3.25% 30’s, appears to have held well. I now recommend adding to those backend positions.
Investors are too myopically focused on expectations of a steep rise in bond yields and on using central bank stimulus to pile back into riskier assets. There is too much complacency. I believe the upside potential for Treasuries prices for the balance of the year is once again being greatly underestimated.
The long end should continue to perform well under various scenarios. If the Fed hikes in September or earlier, the back end should perform well. If the Fed breaks its implicit promise to hike rates in September, its credibility would be damaged: unless of course, it was due to a significant deterioration in the economic or political landscape. Either outcome would likely benefit long Treasury security prices.
I expect USD strength and commodity weakness to continue as well. Weakness in the commodity complex is probably a sign of deep and on-going trouble in China. I expect: EUR to test parity, $/yen 130, $/Cad 1.35, AUD .6500, WTI oil $42. I also expect the US 10yr and US 30yr yields to dip again this year below 2.00% and 2.75%, respectively. Periphery EU spreads should continue to be sold versus Bunds and UST.
“Easy money is not costless” - Anonymous
