A Confused Fed Will Soon Dismiss Rate Hikes Altogether

Real Clear Markets ^ | March 24, 2016 | Peter Schiff

[expat_panama]

The Federal Reserve's years-long campaign to sheepishly back away from its own policy forecasts continued in earnest last week when it officially reduced the four expected 2016 quarter point hikes, suggested back in December, to just two. Given the deteriorating economic outlook, I believe there can be little doubt that the Fed will soon complete the capitulation process and remove all expectations for additional hikes this year. Even before that happens, savvy observers should have already concluded that the Federal Reserve is stuck in the monetary mud just as firmly now as it has been since the dawn of the financial crisis back in 2008.

Rather than actively voicing its retreat in either its March policy statement or in Chairwoman Janet Yellen's press conference, the market-moving policy shift was buried in the minutia of the Fed's "dot plot" information array, in which each voting committee member signals their assumptions of where interest rates will be in various points in the future. Those tea leaves needed to be read to reach the conclusion that policy just got significantly more dovish. But despite the Fed's soft peddling, the policy shift made an immediate impact on markets, with the dollar getting hit by a variety of rival currencies and gold (and more significantly gold miners) climbing to multi-month highs.

But perhaps the greatest casualty of the announcement was the Fed's own credibility, which is now being stretched to the limit. At Yellen's press conference last Wednesday, CNBC reporter Steve Liesman, who has perhaps been one of the most reliable supporters of the Fed's policies, seemed to indicate that even he had grown weary of the Fed's prevarications, saying to Chairman Yellen: "Does the Fed have a credibility problem in the sense that it says it will do one thing under certain conditions, but doesn't end up doing it? And...if the current conditions are not sufficient for the Fed to raise rates,...what would those conditions ever look like?"

Yellen's response was measured and lengthy, but what it really boiled down to was, "Steve, why have you taken our prior forecasts at face value? We never actually offered firm commitments on anything. Nor did we specifically endorse the things that we seemed to have said. And just so you know, you should expect that the things we are saying now will 'fully evolve' over time as well." Or in plain English: "Steve, don't you know by now that we have no idea what we are talking about, that our forecasts are just guesses, and since we normally guess wrong, why should you expect greater accuracy now? If anything, it should be obvious that our guesses are biased in favor of stronger growth, as the intention is for those rosy forecasts to positively influence sentiment, thereby helping to obscure the problems that, for political reasons, we are hesitant to acknowledge".

Talk is cheap, and the Fed buys it by the bushel. But when it comes time to actually do something, it is nowhere in sight. In voicing his frustration, Liesman pointed out that core inflation has gone up the past two months (in fact, it has already breached the Fed's 2% target), that the jobs report was strong (in fact, the economy is creating 200,000 plus jobs per month), and that the GDP tracking forecast has returned to two percent. And while I have explained on many occasions why those data points are all misleading to the upside, Yellen has made no such qualifications. The growing chasm between what the Fed says it is going to do and what it is actually doing is getting increasingly hard for the mainstream to swallow. When it stops going down at all, a market shift of considerable proportions could begin in earnest.

One of the data points that Yellen likes to cling to most fiercely are the reports that show consumers are confident that the economy has improved and that it will continue to do so. But those reports, which I have always believed are poorly constructed, are completely at odds with what voters (who are also consumers) are actually saying at the polls. Presidential primary exit polls in state after state indicate that the economy has been the top issue on the minds of voters. Generally speaking, this should indicate that people are not overly optimistic about the economy. If they were, other issues, such as immigration, national security, the environment, and health care, would be cited as their top concern.

The big surprise this primary season has been the rise of Donald Trump among Republicans and Bernie Sanders among Democrats. Voters aren't choosing Trump because they like his hair or Sanders because they like his glasses. Both are considered insurgents in their respective parties. They represent change and their popularity should be seen as a sign of deeply-seated economic uncertainty in voters rather than confidence. If confidence were high, candidates more closely aligned with the status quo should be on top.

According to both the Fed and its economic lapdogs on Wall Street, one of the few other bright spots in the economy is the fact that inflation is finally starting to ramp up noticeably. Last week it was revealed that the core Consumer Price Index (CPI) had risen 2.3% from the year earlier (Bureau of Labor Statistics), thereby eclipsing the Fed's long-sought 2% target. The economists argue that rising prices will soon lead to rising wages. Yes, consumers are paying more for rent, insurance, food and healthcare, but the long-sought wage increases have yet to materialize. For obvious reasons, consumers tend to avoid celebration if their bills go up and their pay does not.

Higher prices may be the leading reason why consumers are not spending at the expected pace. Last month, economists cheered when January retail sales came in at up .2% for the month (up if you excluded autos and gasoline), according to Commerce Department data. In fact, the Atlanta Fed cited these numbers when boosting its annualized 1st quarter GDP forecast to 2.7% (since revised back down to 1.9%) (FRB Atlanta). But, last week we were told that the January retail sales number was revised way down to negative .4% from the positive .2%. Excluding autos and gasoline, the numbers went down from up .4% to down .1% in February. I don't recall ever seeing larger retail sales revisions to the downside. But because the revisions were so large, the February numbers could be viewed as positive even though they were way below the pre-revision January numbers.

The slowing sales, in turn, are leading to a dangerous increase in business inventories as unsold goods accumulate on shelves. The inventory-to-sales ratio now stands at 1.4, the highest it has been since May 2009, when the nation was in the midst of the Great Recession. In fact, it has never been this high at times when the economy was not in recession. Similarly, data revisions released last week also indicate that we may ultimately post a full year 2015 current account deficit of $481 billion, the biggest number since the recession year of 2008. If interest rates go up, that deficit could grow significantly worse. The industrial production numbers are also on a downward spiral. Recent data show declines for four straight months, the first time since 1952 that this has occurred without the U.S. being in recession. But if we are already in recession, which I expect we are, then at least that statement will no longer be true.

All this adds up to a nearly inescapable trap for the Fed. The economy is weakening while inflation is strengthening. In the meantime, asset prices, which have become the bedrock of any remaining economic confidence, are extremely vulnerable to an interest rate increase.

As a result, we should expect continued jawboning and inaction from the Fed. All it can do is pray that the economy heats up so it can finally do what it has long promised. But if we keep scraping along the bottom like we have, or go further into the danger zone, look for the Fed to take away those remaining two promised hikes just as easily as it did the first two. The last thing the Fed can bear is for a recession that may be bubbling just under the surface to boil over into full view in the months heading into the election. If that occurs, we all may be seeing a great many press conferences from Mar-a-Lago. That is a development that I'm sure Janet Yellen wants to avoid at all costs.

Peter Schiff is the CEO of Euro Pacific Capital.

[expat_panama]

Schiff seems to make a big deal about the fact that the Fed hasn't a clue about things nobody knows about. Like, what else could he expect already?

Then again, maybe his unwarranted snarky rant is meant to balance all the unwarranted fawning that's typically heaped on the Fed, the way folks say that somehow it's the fed's job to give everyone a job etc.

[Alberta's Child]

Good point, but the Federal Reserve Act actually gives the Fed three mandates: maximizing employment, stabilizing prices, and moderating long-term interest rates.

[expat_panama]

Good morning and we're waking up from yesterday afternoon's wakeup call. Or distribution day.  Whatever.  Indexes got hit more than a % in accelerating trade volume (OK so it happens).  Gold'n'silver got hit too tho their prices are both still pearched on their support levels ($1,217.45 & $15.31).  Adding to all that today's claims/durables day:

8:30 AM Durable Goods -ex transportation
8:30 AM Initial Claims
8:30 AM Continuing Claims
8:30 AM Durable Orders
8:30 AM Durable Goods -ex transportation
10:30 AM Natural Gas Inventories

Too much going on.  Somebody please read all this stuff & tell me if there's anything that I'll regret ignoring:

Talking Taxes, Trade, Entitlements & Welfare - Rep. Paul Ryan, U.S. House
Ryan Looks For Ways to Push Supply-Side Gospel - Jonathan Chait, NYM
Growth Is What Matters, and Cruz Has Best Plan - Louis Woodhill, RCM
Cruz Seeks Economic Wisdom In Wrong Place - Barry Ritholtz, Bloomberg
Oreo Closure Is Proof of Trump's Loser Trade Policy - James Bovard, USA
When Did GOP Become Anti-Trade Party? - Editorial, Investor's Business
Great Britain Must Not Depart a Very Successful EU - Steve Forbes, Forbes
Europe Drowns Under the Cost of Welfare - Matthew Lynn, Daily Telegraph
North American Oil Will Win In the Long Run - Dalan McEndree, OilPrice
Why Market Pros Don't Believe Rally Will Last - Anthony Mirhaydari, TFT
You've Been Warned, This Is A Bear-Market Rally - Doug Kass, RealMoney
How Much Do Pres. Elections Impact Markets? - Mark Hulbert, USA Today

[grania]

The decline in interest rates in savings started with GWB, and now they're just about 0%. They're negative for folks who can't afford to reach minimum balances and as a result have to pay fees to maintain their accounts. It's now almost 16 YEARS years of non-existent interest on savings.

And what's the result? A severely shrunken middle class and an economic recovery that hasn't happened for 90% or so of the population. It has to be intentional, the destruction of opportunity to move up for the vast majority of US citizens.

[expat_panama]

three mandates: maximizing employment, stabilizing prices, and moderating long-term interest rates.

That is their mandate as revised in the 1970's, but before then it was just prices. The thing is while the Fed's equipped to deal w/ inflation (which they've --imho-- been doing a decent job) they got absolutely no ability to make the economy in general do anything. Neither does the president or congress for that matter but at least those guys control tax'n'spending and expanding regulations. Or fail to control them.

At any rate, besides meet and talk the only thing the fed can do is weakly nudge interest rates to keep prices stable.

[EBH]

The Fed has no clue what’s going on, because the Executive Branch refuses to comprehend we have a war on several fronts! While Bush is constantly marketed by the left as a complete failure, at least he acknowledged some sort of war-like footing. 0bama and his ilk are in complete denial of their foreighn policy failures and having pushed the world to the brink of an Armageddon like war.

Add onto that the “hidden” currency war going on!

Add onto that the “hidden” oil war going on with the middle east oil cartels and ISIS

Add onto that nobody I know thinks the Iran deal is going to bring peace to the middle east

No, the Fed has no clue what they are doing because the darn world is at war and nobody realizes it yet, except for the common citizen!

[bert]

By asking us to read the stuff, you destroyed my illusion of your office with masses of papers and stuff you read and read and read and then selectively post those you thought we should benefit most from.

Any way my reading of the piece on Ryan’s speech yielded a very conservative excerpt from the author.

“He continues to favor the same combination of very large tax cuts for the affluent and very large cuts in social spending for the poor. He simply places more emphasis on his belief that the beneficiaries of social transfers tend to be harmed by having their work ethic sapped.”

[Alberta's Child]

Low interest rates aren't a cause of an economic malaise. They are an effect of an economic malaise. In an ideal world where a government isn't creating money haphazardly out of thin air, paying interest rates above 0% only make sense if you have some kind of expectation that there will be growth in the economy over the long term. An economy only grows if population and productivity grow, and the U.S. just hasn't seen sufficient growth in these areas to warrant any confidence among investors.

[palmer]

Schiff is being nice to the Fed by tacitly accepting their premise that the loosening of credit actually helps the economy in the long run. It does not. It only undermines the dollar and that makes long term investment more attractive. People are confused about that thinking that the current relative strength of the dollar means that it is not being undermined. But right now the dollar is strong because of the giant carry trade unwind last year following China's market collapse early in the year and now the ECB ramping up QE to undermine the euro.

The dollar is relatively strong because it is the ECB's turn to undermine all the world's currencies. But they are all being undermined. It is the ECB's turn to reinflate the commodity bubble and their turn to restart the carry trade to reinflate the developing market bubbles especially China's. It's not hard to predict what's next. The bubbles reinflate albeit with a weaker economy overall. The bubbles pop again, The market tanks again. Then it is the Fed's turn to reinflate. Or maybe Japan. Doesn't really matter.

Since they are all in collusion and fundamentally corrupt they will try to hide it. In past years we saw big purchases of treasuries by islands. Then by Belgium. Now Belgium has been blown up so it will have to be someone else.

[Moonman62]

And what’s the result? A severely shrunken middle class and an economic recovery that hasn’t happened for 90% or so of the population.

...

W’s top priority was growing the government, which made some people happy.

[grania]

Low interest rates aren’t a solution to the problems. If a responsible middle class can’t acquire savings, how is there ever going to be small business formation or an incentive to get out of debt and start saving?

[bert]

Well, he did say this.....

“it has never been this high at times when the economy was not in recession. “

He is saying we are infact currently in a recession and there are numbers to prove it besides waiting for two consecutive quarters of negative GDP.

Both Cruz and trump should take his message and deliver it from the stump. “I will take steps to get us out of the current recession.....blah blah bah.” It’s still the economy stupid.

[expat_panama]

decline in interest rates in savings started with GWB, and now they're just about 0%.

We hear that line from trolls on the FR all the time and we need to tell those guys to go back to the lefty forums where they came from.  Fact is that interest rates have risen and declined for hundreds of years and the old "bush's fault" cr@p doesn't wash.  The interest bottoming we've had for such a long time began well after the '08 election and ended last year when Yellen started the first hike.  It's all there w/ say, historic prime rate data or with T-bill rates. 

The rising rates we got now is slowing an already comatose economy, cutting our exports, and will end us up more tax hikes. I don't see this being very pleasant at all.

[expat_panama]

...the current recession....

You know it and I know it but everyone else hears the dems saying an economy is good or bad depending on who's in office --tho Bill Clinton's recent gaffe about the terrible past 8 years was telling...

[rdcbn]

The hope that the Fed can ignite an inflationary price wage spiral (didn't we used to try to avoid them, BTW?) is misplaced and may backfire on the Fed

The price -wage relationship has been broken by massive off shoring and destruction of our manufacturing base

It is now very possible to have price inflation without wage inflation because low cost imports from low wage and low cost to manufacture foreign countries keep the lid on wage pressure and prevent wage increases to American workers

In fact, under our brave new world order,rather than ignite a traditional old school price-wage inflationary spiral, price inflation actually puts deflationary pressure on domestic wages as domestic producers scramble to reduce their costs to offset inflation driven higher priced raw goods and other inflated costs .

Domestic producers are stuck between the rock and a hard place because they cannot rise prices because of competition from cheap foreign imports and yet they are faced with increasing costs for raw goods, regulatory burdens, and (until recently) energy costs.

One of the few places they can cut is worker wages so they are faced with the choice of decreasing labor costs or going out of business.

This has been going on since late 1990s when the rise of China threw conventional economic wisdom out the window.

This is also why the Fed has been able to keep interest rates so low for so long without creating a serious inflationary spiral.

It is also one major reason why the Feds low interest rate policy has not been able to accomplish its desired economic goals.

You can't overheat a fire when have reduced the logs to smoking embers no matter how much air you blow over it. All efforts to force more air to blow over the embers just burns them out faster without generating any more heat.

And that is exactly the situation we find ourselves in

Sucks to be us

We may see inflation eventually, but by then things could be so screwed up it may be sudden and hyper inflationary.

Until then, unless our foreign competition is forced to raise their prices, all inflation will accomplish is to drive wages lower or put companies out of business as domestic producers.

The only real solution is to reinvigorate our domestic production but every policy the Obama Admin has enacted across the board does exactly the opposite

Obviously, none of this is sustainable in the long term so eventually something will have to give at some point in the future.

Hope I'm not around when it does

[Soul of the South]

“And what’s the result? A severely shrunken middle class and an economic recovery that hasn’t happened for 90% or so of the population.”

But we have free trade!

We have deindustrialization!

We have low inflation thanks to a CPI that doesn’t include food prices!

We have 92 million working age Americans without jobs!

We have enjoyed a declining standard of living for the average American household for nearly 20 years!

We have a shrinking middle class!

We have lost many of our civil liberties to the “war on terror”!

[Mr. K]

Pretending the economy was getting better- enough to warrant minor rate increases - was a mistake of epic proportions- when some places are actually introducing NEGATIVE interest rates

[expat_panama]

...price -wage relationship has been broken by massive off shoring and destruction of our manufacturing base...

That sure is the feeeeling everyone seems to have.  Of course, hard numbers in bank accounts/payrolls tell a different story (which is what we base our decisions when we're sober) but hey, this is the FR and feeeelings rule!

Getting close to opening bell so I need to get back to the facts that

--the price-wage relationships always obey the laws of supply and demand,

--off shoring is considered "massive" by folks that want to outlaw it all together,

--destruction of our manufacturing it the best fanatasy/scifi story around since Godzilla.

[expat_panama]

Pretending the economy was getting better- enough to warrant minor rate increases

Yeah that was my take too.  Seems that the "economy's fine" buzz was so intense last fall that Yellen got overwhelmed.  She's also been swamped by numbskulls saying ZIRP is the Great Satan and had to be stopped at all costs.  Personally I'm expecting that cost to end up being pretty steep.

She seems to be taking seriously this nonsense that the Fed controls employment and is forgetting her responsibilities w/ price inflation.  There is none, and I see her rate hikes pushing us into a ruinous deflation.

[rdcbn]

Actually, the economic observation came from ex Fed Chairman Alan Greenspan, not me