Fed Shock & Awe?

As Janet Yellen is passing the bubble, excuse me, the buck, wrong again, the baton to Jerome Powell this week there is some chatter as to whether Jerome Powell will use the occasion to introduce shock & awe to a market that’s overheated and has overtly trespassed into bubble territory.

Some thoughts on that.

Firstly a disclosure: I’m no fan of central bankers as most of you probably know (see: Big Little Lies by Central Bankers) and the move to a new Fed Chair may well be correlated to shaky market action to come as I outlined in 2018 Crystal Ball Predictions.

At the current moment markets in general expect the Fed to continue on its tinkering slow pace to raise rates moderately, perhaps 3 times in 2018. Indeed the base case for this week’s meeting would simply to expect more of the same and a celebration for Janet Yellen for a job well done.

After all she’s presided over an aggressive fed balance sheet reduction:

And she’s worked really hard to normalize rates:

A profile in courage.

Oh, excuse my thinly veiled sarcasm, but my premise has been that the Fed is behind the curve in raising rates because they have been, and continue to be, scared of markets. “Do not upset markets’ has become the prime directive. A large chunk of economic growth is now dependent on ever rising equity prices. Bursting the bubble would risk recession.

And the Fed knows this hence their deliberate cautious approach to everything. Problem is markets have taken the cue and gone wild as the Fed’s cautious efforts to raise rates have continued to send a dovish signal while tax cuts and global central banks printing efforts have lit a FOMO fire under markets. Indeed the Fed’s efforts have been so meek they concur with the loosest financial conditions in decades:

So despite the public cooing this is really Janet Yellen’s true legacy: Dovish, dovish and more dovish.

But who can blame her? After all she’s learned from the best and the lesson was: If you throw enough money at markets you get called a hero:

If the Fed has learned anything from the excesses of 2007 it’s not apparent to some observers. From Gluskin Sheff’s David Rosenberg (via Carl Quintanilla):

Well, if the Fed is scared of markets then their excruciatingly slow pace makes perfect sense. But not everyone thinks the Fed under a new Fed Chair is cowering in the corner. Here’s David Rosenberg again:

“The consensus is that Jerome Powell will not rock any boat and is a Yellen clone. I’m not so sure. He doesn’t sound that dovish to me”.

Will Jerome Powell rock the boat and introduce shock and awe and raise rates on a market that doesn’t expect it?

A few considerations:

Markets are already raising rates without the Fed. Here’s the 10 year busting out above its trend:

And as minuscule as all this appears the impact is already real:

So Jerome Powell has a decision to make, be a Janet Yellen clone, or show markets that a new sheriff is in town and that he means business.
But by doing so he may risk upsetting markets. The classic trap the Fed has placed itself in.

And by the looks of volatility markets are already at the verge of getting very upset as the $VIX is testing a breakout of its multi year trend line:

Nah, why risk it, probably be best to just pass the bubble and smile:

After all, it’s easier to be easy and let the bubble keep inflating. There’s just one problem with all this and it’s a major argument as to why the Fed should raise rates now and aggressively so: As I argued in Tax Cut Hangover: With tax cuts removed as a potential stimulus tool to deploy during the next recession the Fed is now the final line of defense again. And the Fed needs tools in addition to QE4 down the road. It needs to be able to lower interest rates again when the time comes. And 1.25-1.50% is just not a good enough height to start from.

What say you Jerome? Shock & Awe or blow more air into the bubble?

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Categories: Opinion


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