December 19 marked the day the Fed may have decided it’s going “all in” on the idea of a “strong U.S. economy.”
The Fed locked in an increase of the Federal Funds Rate from 2.25% to 2.40%, and it will increase the primary credit rate to a full 3.00%. These December increases were pretty much anticipated back in early November.
The increases came in spite of commentary by Jeffrey Gundlach from Doubleline, who said the Fed shouldn’t have raised rates:
"I don’t think they should... The bond market is saying there’s no way the Fed should be raising interest rates."
From here on out, things get murky, and that uncertainty could very well set the tone for 2019.
Let’s start with the Fed’s now-infamous “dot plot,” below (sourced from their December projections document):
As you can see in the “dot plot” above, chances are Federal Fund rates will be soaring over 3 percent in 2019. In 2020, there is still a good chance rates will soar even higher, nearing 3.75 percent. It also looks as though rates will stay at or above 3 percent for the foreseeable future.
That means credit is about to get (and stay) more expensive. Growth is likely to slow down, and the cost of commodities could rise dramatically.
In fact, according to the Bureau of Labor and Statistics, food and most energy prices are already on the rise (emphasis ours):
"Food prices increased 1.4 percent for the year ended November 2018. Prices for food at home increased 0.4 percent, while prices for food away from home rose 2.6 percent. In November 2018, prices for cereals and bakery products rose 1.3 percent, the largest 12-month increase among the six grocery store food groups.
Within energy, gasoline prices rose 5.0 percent for the 12 months ending November 2018, and fuel oil prices increased 16.1 percent. Electricity prices increased 0.6 percent and natural gas prices declined 2.1 percent."
But according to the Fed’s December statement, things are “roughly balanced.” If this is “balanced”, it would be interesting to see what the Fed considers out of balance.
It seems like Fed Chairman Jerome Powell hopes that people will just take his “spoonful of sugar” to help this bad tasting economic medicine go down.
The “Poison Pill”: Real Inflation and QE Unwind
The Fed, and the U.S. Government in general, doesn’t like to report real inflation. They report CPI inflation at 2.2%, which is missing energy and food costs (see chart).
As you can see in the “adjusted” chart, inflation jumped right after the 2008 financial crisis, and then again in 2016.
The Fed likes to create the illusion that 2% is somehow an ideal target. They call it their “symmetric objective rate.”
According to the Fed, so long as this target is “out there” and decisions are being made according to it, inflation will magically stay in line.
As you can see, real inflation was still trending upwards to the end of November 2018. We’re getting dangerously close to levels of inflation not seen since 2011. And with the cost of commodities already going up, it doesn’t look good.
Obviously the trend could change, like it did in November 2006 before spiking over 5% during the last financial crisis. Ultimately, no one really knows how this will play out, no matter how Chairman Powell spins it. Although Jim Cramer might have an idea (emphasis ours):
"Let me put it very simply: Powell wants a slower economy than we have. He wants one that hurts Main Street… He has his reasons, but please, don’t go into denial here. The Fed is perfectly happy to gradually strangle … the U.S. economy in order to stamp out inflation."
And speaking of spin, all of that money the Fed printed up during its Quantitative Easing (QE) phase is being shed off in a plan that started back in late 2017. Powell calls it “balance sheet normalization,” except the balance sheet appears anything but normal.
The money being unwound has to go somewhere, and a chart from ZeroHedge paints another murky picture:
As you can see, the Fed’s holdings (bottom graph) from unwinding their QE program don’t look so good. When the “piper has to be paid,” who knows what will happen.
So strap in, because 2019 is going to be a murky year.
Don’t Let the Fed’s Murky Plans Leave Your Retirement “Dead”
Wolf Richter explained the Fed’s stated objective well, and linked to their first “stability report”:
"Preventing another financial crisis – or “promoting financial stability,” as the Federal Reserve Board of Governors calls it – isn’t the new third mandate of the Fed, but a “key element” in meeting its dual mandate of full employment and price stability, according to the Fed’s first Financial Stability Report."
If their objective is full employment and price stability, then they have a lot of work to do to ensure 2019 doesn’t make things worse.