Today will be a historic event for those of us who are both historians and economic geeks.
The Federal Reserve Open Market Committee reveals the results of their meeting today and there are no good choices as their inept policy decision have lead to the problems we are witnessing as a nation in this era. The problem is that of the four options the Fed has on the table today, each one comes with a major risk both economically and politically.
To review the basics for today’s meeting, all one has to do is look at the real inflation numbers. The CPI-U was distorted by new benchmark revisions but the data served the purpose of reminding the Fed that inflation was far from under control as service sector inflation still surges well above a 6% annualized rate. The favorite measure for the Fed economics, the extremely lagging Core PCE, still indicates a much higher inflation rate than any target they desire plus the problem that it appears to be evolving into a systemic inflation instead of a singular time based event due to loose monetary policy.
The best measure, the Atlanta Fed’s Sticky CPI once again demonstrates that the Fed is still losing the war on inflation and that it continues to persist at an almost 7% annualized rate despite the interest rate increases executed thus far.
Even with M2 contracting at a snail’s pace which is the desired Fed policy while M2 velocity finally bounces off the historic lows, the bank failures recently experienced in the US may disrupt the Fed’s plans to fight inflation for the long term.
Thus as credit creation finally begins to expand at a more normalized rate approaching the desired level above 1.50, the economic disruptions recently experienced may well spook the Fed into a rash short term decision with massive implications for long term economic stability. The US 2 year Treasury action as of recently best demonstrates the insane amount of instability being injected into the financial system and the US economy as a whole:
This leaves the Federal Reserve with the choice of facing what I like to call the Four Horsemen of the Bondpocalypse as there are no good choices today and the smart decision is not the one this politically sensitive Fed will make, in this author’s opinion. Unless the tough choices are made now, the long term damage may well indeed induce the systemic reset many of us fear is on the horizon. Here are the options with this author’s opinion outlined below.
1. The Fed Cuts Rates 25 points
This is the desired choice of the equity bulls who want endless funding for the silliness which the US has witnessed since 2009. The bubble isn’t big enough and the economy can’t handle any more increases. To them inflation is a nuisance to be endured by the little guy and they don’t care if the average annual CPI persists above 6%. Odds of this happening: Less than 10%
2. The Fed Raises Rates by 50 points
By increasing rates by 50 points it would demonstrate that the Fed is serious about inflation and is willing to push the economy into a short, sharp recession to bring inflation back under 4% annualized and stabilize the US dollar at a higher rate. This was my prediction at the end of last year and I still think it is quite possible, but due to the events of the past month, now fading as a probability. Odds of this happening: 20%
3. The Fed Raises Rates by 25 points
A 25 point increase with a strong commitment to continue raising rates until inflation stabilizes in the statement and press conference might have the intended effect of a shocker like a 50 bps increase as outlined above. However the duration of such a fight, especially if more regional banks begin to fail will be called into doubt. This is the most likely outcome as of yesterday morning per Wall Street economists and banks, but now is in doubt after leaks from Nick Timiraos, aka the Fed ‘whisperer’, may tell the tale of the tape today. Odds of this happening: 30%
4. The Fed Does Nothing
There appears to be a growing train of thought that due to the recent banking instability the Fed should and will do nothing. Goldman Sachs apparently believes this to be the case:
Naturally this is the highest probability now and if I were playing the markets today, that is how I would proceed. The “pause” would create reassurance that the Fed is aware of the financial instability in the banking system, but once again illustrate Powell’s inability to understand basic economics and the impacts of monetary policy on the global financial system. Odds of this happening: 40%
If indeed the Fed does nothing, it would fit with their recent historical blunders of failing to recognize that the hardest course of action is the best one for the long term. It would turn Powell’s rhetoric about fighting inflation from a Volckerian wizard into a Burns’ like fiasco overnight. Even a 25 bps increase with a weak statement postulating about a future pause would be equally as bad for the long term inflation outlook. The Fed would invite direct comparisons to the late 1970’s where the Fed proclaimed repeatedly that inflation was stabilizing when in fact it was embedding itself into the economic system, creating a vicious wage-price spiral.
Sadly, a course of no rate increase but paying lip service to inflation is the “political” choice for this Fed to remain in favor of their constituents; not the American people, the Wall Street and DC elites. What most forget is that inflation is the ultimate tax increase on the lower and middle class thus the easiest course of action is to blame inflation on their unwise financing and spending ways because they are economically ignorant.
The problem this time is that the US economy structurally cannot endure another 1970’s wage-price spiral. Due to decades of speculative bubbles, out of control fiscal spending resulting in historic debt levels, and an American consumer that has been taught that the government will always bail them out, the results may well turn the United States into a larger Argentine model, where inflation is used to “preserve” existing financial assets in the eyes of the public.
Preserve that is, until the inflation becomes so intolerable at a higher sustained rate that the weight of the price increases destroys the political and economic stability of the system it was intended to protect.
Buckle up boys and girls, today and the remainder of this week will make sure we are in for a wild ride.