Oh my, how things have changed since late last year.
New York Fed President William Dudley, one of the big and influential doves on the policy setting FOMC, drove home the point today when he said at a roundtable discussion that the economic outlook was “pretty good,” and that he wasn’t seeing too much of a signal in the low bond yields.
Longer-term yields have caused a lot of gray hairs. While short-term yields have risen in response to the Fed’s rate hikes since December, longer-term yields have actually fallen since then – a sign that the bond market doesn’t believe the Fed’s current projections of four more rate hikes over the next two years, which would bring the Federal funds rate target to a range between 2.0% and 2.25%. By contrast, the 10-year yield is 2.18%.
Though low, those longer-term yields are still relatively high compared to the near-zero yields in Europe and Japan, he said. The Fed will have to keep raising rates at a gradual pace in order to avoid having to raise them so sharply in the future that it might trigger a recession, he said.
Dudley and the “suddenly hawkish” Yellen, as she has come to be called, are walking in lockstep. At its meeting last week, the FOMC has raised its target for the federal funds rate for the third time since December, like clockwork at every other meeting, to a range between 1% and 1.25%. The Fed has penciled in one more rate hike this year, and several more over the next two years.
In addition, it has now put in place a plan to unwind QE, starting “this year,” possibly as early as September, which will have the opposite effect of QE.
QE was designed to bring down long-term yields and mortgage rates and inflate asset prices across the spectrum. It worked like a charm. Unwinding QE – “balance sheet normalization,” as the Fed calls it – will do the opposite.
Gone is “flip-flop Fed” of 2015 and 2016. This Fed is on a mission. It has a plan. There is little dissent within the Committee on rates and no dissent on reversing QE. They’re moving forward. It is a tightening cycle like no other before. In prior tightening cycles, the Fed raised its target for the federal funds rate. This time around, it’s also reversing QE.
The Fed heads don’t even expect a great economy, just the same lousy economic growth we’ve had for years, with median projections of 2.2% in 2017, 2.1% in 2018, 1.9% in 2019, and 1.8% in the “longer run.” Since late last year, slow growth is no longer an excuse for loose monetary policies.
And the tightening cycle will continue – that’s what Dudley in essence said. The Fed isn’t going to be sidetracked by quivering economic data. This includes inflation, which came in lower than the Fed had wanted, but Yellen made a special effort to explain it away [Why “Suddenly Hawkish” Yellen Brushed off the Dip in Inflation].
And today, Dudley marched in lockstep with Yellen. He pointed out, according to The Wall Street Journal, that slowing inflation and signs of a slowing economy haven’t caused any worries. He was “very confident” that there is “quite a long ways to go” in the third-longest economic expansion in US history.
Something changed at the Fed no later than September last year, when another dove, Boston Fed governor Eric Rosengren, floated the idea of unwinding QE, and no one at the Fed tried to shoot down the idea!
He has been fretting since 2015 about the commercial real-estate bubble in the US, and the damage its $4 trillion in loans could do to banks, particularly the smaller lenders that are so heavily exposed to it. Collapsing collateral values of CRE were a big factor in the Financial Crisis. This time around, the new CRE bubble is far bigger.
That isn’t the only asset bubble the Fed is worried about. Since assets are so highly leveraged, any major decline in prices (collateral values) can wreak havoc on the financial system. So the Fed wants to engineer a soft landing for asset prices, rather than let this get out of hand completely. And the Fed will continue to tighten until its gets some kind of landing by the markets.
But the record of Fed-engineered “soft landings” isn’t good. The Fed is very reliable when it comes to inflating asset prices. But soft landings? The last two tightening cycles and attempted soft landings ended in crashes: the dotcom bust and the Financial Crisis.
Now the Fed has created an another array of bubbles and is belatedly fretting about them. But this time, it’s different. This time, the bubbles are even more magnificent than those leading to the prior two “financial events.”
So the Fed laid out its plan to unwind QE by $600 billion a year. The markets shrugged. That’s how it usually is. But “painful sell-offs eventually materialize.” Read… Markets Blow off the Fed until Next “Financial Event”
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If the Fed talks about financial instability at this stage in the game, it may create financial instability. They’d rather talk about how the economy is doing well and use that as a excuse to raise rates.
If the Fed admits there are stability risks, it would be obvious that the Fed created them, so the Fed won’t talk about it
Because Central Banks lie to the public in furtherance of their goals, it makes you wonder whether they are legitimate institutions.
MHO is that they are legitimate institutions, since they tell the public what it wants to hear.
By that standard, we should doubt all institutions with skin in the game who are forced to comment on financial markets. From the President to the Fed to bank CEO’s, they all publicly downplay the most dire risks for fear of rattling markets. Think “taper tantrum”.
Meanwhile, one hopes, if these officials are good at what they do, they beaver away at mitigating these same risks.
(By the way, I think it’s fair to say that investors and the financial papers, which operate as a sort of proxy for the investing class, demand this behavior.)
“By the way, I think it’s fair to say that investors and the financial papers, which operate as a sort of proxy for the investing class, demand this behavior.”
Bingo. Everyone endlessly harps about the Fed rigging the markets, but when the Fed actually tries to tighten, these same folks protest the loudest.
I hear that US household spending is 25% higher than income compared to just 16% before the 2008 crash. That means that Americans are borrowing like mad both in secured (against inflated property valued) and unsecured (junk loans) segments.
It seems highly unlikely that the FED will ever significantly raise interest rates. Oh .3% here, .1% there, but they will take care to ensure that the increases are not enough to disturb the status quo. They can’t. They have engineered an enormous increase in the money supply without inflation by limiting the distribution of that money to the small group referred to as the ” 1 percent”. There has been almost no trickle down to most of the population or even into government coffers.
Consequently eternal debt has become necessary for the rest. At one time debt was looked at as a temporary thing, to be paid off. (See definition of loan.). But a cultural paradigm shift has resulted in most people (and governments at all levels) carrying debt till death. Houses, cars, credit cards, medical costs, education, etc. are carried forever and not paid off. And, as has been pointed out in this column, borrowing is keeping stock prices up through non-productive means such as stock buy backs and mergers. All of that depends on an affordable rate for the masses and a good spread between what they pay and what the financial system pays for the money it loans.
Any significant increase in rates will wreak havoc on this finely balanced charade. Indivuals will probably suffer directly less than through the affect on state and local governments.
So, the FED won’t make any meaningful change inn rates. Oh, rates may someday rise. But when rates rise it will be due to causes that the FED can’t control.
Even with all the money printing and credit, the majority of people are starved of cash. And all the corporate stock buybacks are a disincentive to actual productive activity. These companies are hollowing out, they are at peak compensation and peak asset stripping.
Strip and flip and related techniques are highly compensated. My take is that the U.S. economy is being liquidated, since that’s what the evidence is saying and that’s what your corporate masters want. Naturally the show the FIC puts on is just to hide it, and they of course lack any motive to be honest about it. People in my own circle are seeing it one by one, but it’s a hard thing to buy into. Meanwhile the screws keep turning, day by day, year by year, slowly so most people never notice it.
All in good time.
“Even with all the money printing, the majority of people are starved of cash.”
There was no money printing. QE was not money printing. It was a glorified asset swap.
They’ve already raised their target range by 1 full percentage point, from about 0%. That’s a real start.
How many false starts were after 1929? And at the time, debt actually mattered. Considering asset price inflation, and the “wealth effect”, the economy is stagnating at best.
It’ll be interesting. Q1 US GDP was 1.2%. I doubt we see above 2.0% in Q2.
Housing starts were weak in both April and May. Multi family permits were down y/y.
We know about autos. Store retail is a basket case. Both auto and credit card delinquencies are at multi year high. Restaurant sales comps were down 1.1% in Q1 y/y.
Here in downtown Bellevue, WA, both the Sports Authority and Pier 1 imports stores have been sitting empty since last summer. The commercial developers and brokers have got to be getting nervous.
Too many health and Fitness clubs trying to fill the void – Orange Theory, Planet Fitness, Pilates, Hot Yoga, etc. Gosh, it’s like they are on every corner at this point.
I think we have reached peak everything. Peak demand, peak debt, peak fitness, peak technology, you name it.
Will we get to see a 50bp increase from those guys in the next 12 mos. ? Tough call, i think.
We will not have honest markets or sound money until the counterfeiters and racketeers at the Fed have been locked up.
And this is not going to happen ever again
Not until these Keynesian fraudsters collapse the financial system. In that case they better hope their oligarch patrons save some seats on their Gulfstreams to fly them to some offshore hidey-holes in a non-extradition country.
“There is little dissent within the Committee on rates and no dissent on reversing QE. They’re moving forward. It is a tightening cycle like no other before.”
It’s a proposed cycle like no other before. Since the US economy is now based on housing and stocks I can’t see rates rising if either of those ‘engines of growth’ slow. Monetary policy is the only policy for America. The Trump trade is deader than dead, yet the market keeps rising because the big players know low rates are here to stay.
You hit it dead on with your earlier comparison to Japan. The USA is becoming Japan without the exports or social cohesion from a uniform population. Not sure why the Japanese market didn’t float up forever on low rates, but the US is the primo reserve currency.
Just invest in something that would have done well in Japan in 1988 and you’ll do fine.
Ramen noodel inc?
Surprisingly Cracker barrel in the States is doing very well. Never seen one myself.
https://finance.yahoo.com/quote/CBRL/
You are on the right web site. Wolf knows a wee bit about Japan.
Well here in Oz they sure don’t think US rates are going up as the A$ has continued to go up…………
The Teflon A$ has shrugged off every bad piece of economic news and gone up.
The Australian dollar has a secret weapon: China.
All the real estate Chinese speculators buy in Melbourne and Sydney and a sizable chunk of the commodities keeping the wheels of the Chinese economic miracle spinning are paid in Australian dollars.
As the People’s Bank of China cannot issue Australian dollars, at least not yet, they have to be bought on the open market, thus propping up value against other currencies.
Australia trails behind only the US as the favorite destination for Chinese money… and this is without taking into account Chinese money passing through front companies in Singapore, Malaysia and other financially accomodating countries: between 2010 and 2016 US $92.8 billion officially poured into the Australian economy from the Middle Kingdom. This of course doen’t take into account the Shadow Banking empire quietly spreading its wings over the Pacific Rim.
As Australia is a developed economy, the bulk of that money had and has to be converted into local currency before being used to carry out real estate speculation or to pay iron ore shipments, effectively providing a massive boost to the currency on open markets.
As we’ve seen time and time again, Chinese “investors” seem largely unconcerned with anything going on outside their country. Their only preoccupation appears to get as much money out as soon as possible, even if this means grossly overpaying or creating massive bubbles that will collapse right on top of them.
>>longer-term yields have actually fallen since then – a sign that the bond market doesn’t believe the Fed’s current projections of four more rate hikes over the next two years,
I wonder about this. Is it rather that people here and abroad are scared crapless about the stock market and other markets, and are therefore piling into longer-term US T-bonds for safety? That would also cause the interest rates of those bonds to fall.
Yeah, long yields fall as a flight to safety. Nobody is buying strong growth, and if inflation growth keeps trending lower… rate hikes are DOA.
I think Wolf is getting taken by the Fed tough talk. Yeah, they’re REAL serious about rate hikes this time– just ignore the last 7 years…
I think the most likely scenario where they raise again this year (and I doubt they will) is ONLY so they can cut in 2018. If inflation fails to hit their target, or there are any stumbling points between now and then (China, EM, strong dollar, etc.) they will not raise again, and may even cut.
“Yeah, they’re REAL serious about rate hikes this time– just ignore the last 7 years…”
The Fed was protecting Obama and his legacy by not raising rates during his 8 years, with the exception of one .25 increase in Dec. 2015.
They have no problem now that they can blame the collapse on Trump, hence 3 rate increase since the 2016 election, and possibly do it before the mid-term elections in 2018.
Justme,
It is not surprising that U.S. long-term rates have fallen while the Fed has raised short-term rates. I have been investing for about 30 years and I have seen it happen in the past where short-term rates were going up while long-term rates were declining. Here is how it goes. The Fed raises short-term rates. Higher interest rates typically means slower economic growth which in turn usually causes inflation to decline. This is good for long-term bonds hence investors buy long-term bonds expecting a slower economy and lower inflation in the future. At least that is how the investor’s reasoning was in the past.
Fed is just focussing on U3/U6 below NAIRU estimates, job growth, and most components on Core PCE being over 2% and only problems sectors like auto, food, homewares dragging it lower. As such they will keep hiking, albeit slowly, until they create a problem.
The Fed starting getting aggressive on hiking after Trump was elected. The economy was actually better last year (2016) but they didn’t hike. Surely due to Obama’s request to help Hilary get elected and polish up his legacy.
The Fed knows things are getting worse. That a recession is coming. As such, they need to get out in front and get rates up some. The recession will be blamed on Trump, not the Fed. Watch how it is spun.
Then the Fed will do what it has to to counter the recession. Much more QE very likely.
As Wolf stated, “Something changed at the fund no later than September of last year,” which was when everyone thought Clinton was going to win.
I love that people who’ve been harping about the FED and QE for years are now complaining that the unwinding is a conspiracy to make Trump look bad. I don’t think he needs the FED’s help in that regard.
What would the past administrations legacy look like without the Fed holding rates low and QE?
The Fed raised once under Obama (December 2015), and twice thus far under Trump.
They’ve raised rates 50 basis points under Trump.
That’s not aggressive.
*I’m sorry, twice under Obama (December 2015 & 2016) and twice under Trump. You could put the second one under Obama in Trump’s column, but I would say they’re still far from aggressive.
If they raised rates 75 basis points in a meeting, I would say that’s more aggressive.
I do agree they are giving themselves ammo to cut in the future.
Micro-economic effect for a few of us peons: If the Fed “stays the (new) course”, our multi-year, zero interest rate auto loans will leave more cash in our bank accounts to earn a decent rate of return, for a change.
Bond-king Jeffrey Gundlach predicts a 6% yield on the 10-year Treasury around the time of the 2020 election.
https://www.advisorperspectives.com/articles/2017/06/14/gundlach-rates-are-going-up
That’s laughable. He’s delusional, or has an ulterior motive.
Bond king my a**.
““Bond prices are not going up,” he predicted. “Yields have been rising since July 2012 in a certain sense,” he said, “and they have certainly been rising in a significant way since July 2016.””
Yields have not been rising since July 2012… the 10-year hit a low a 1.5% in 2012, and a lower low of 1.3% in 2016… they spiked after the election, and they’ve been collapsing back down to lows ever since.
I suspect he doesn’t actually believe that.
Keynesianism would have created jobs and have the Stare buy the banks in crisis instead of lending them money at a ridiculous low interest rate. There wouldn’t have been anyone “Too big to fall.”, in fact the State would have let them fall to buy them cheaper.
You mean Friedman Fraudsters. All of this manipulation is from Milton Friedman’s monetarism
playbook.
Going to raise short interest rates until insurance company directors start going to jail?