The boys and girls in the casino got some well-deserved whiplash during the last two hours yesterday with S&P 500 moving up and down by a total of 35 handles in response to the Fed’s minutes and Powell’s jawing afterwards.
In a narrow technical sense it was all very explainable. The days traders and the robo-machines had gotten themselves all excited about an alleged inflation shortfall, jumping to the wager that the Fed would be in a rate cutting mode by the fourth quarter.
Not for the usual reason of warding-off recession, mind you, because everything on the growth side is still allegedly goldilocks and unicorns. No, the bet here was that the Fed would soon “stimulate” (what else does it do?) in order to goose “low-flation” back toward (or above) its sacrosanct 2.00% target.
As we discuss below, that’s new territory. Until a few weeks ago, the “stimulus” call always rested on the pretext that growth and jobs were weak or at least wobbly. But now we had a call to cut rates for the naked purpose of goosing inflation, and not just any old inflation index, but precisely the PCE deflator less food and energy.
Tall Paul Volcker is still very much alive (and wrote a nice book recently), but he’s probably rolling in his grave, anyway. This latest burst of rate cut enthusiasm essentially puts the central bank in the inflation promotion business, a heresy by every traditional notion of sound money—even as it unceremoniously tossed the Phillips Curve aside and went straight to jacking up the price index.
That is, the recent chorus of rate cutters weren’t touting the need for more inflation as a necessary cost or lubricant to levitate growth and jobs: It was just a paint-by-the-numbers call to ratchet-up the inflation index for its own sake because the Fed’s inflation target must be achieved, come hell or high water.
Accordingly, the traders were expecting some Fed word clouds expressing consternation about the inflation shortfall and a wink-wink, nod-nod signal that a rate cut was just around the bend.
But Powell for once regained a modicum of common sense. In his presser he averred that the recent inflation dip was all due to transient factors and that it would soon be back on track— implying no sugar for you, boys and girls.
What happened then was not a wink-nod, but a bang-bang, as the startled traders slammed their sell buttons. As one veteran fed watcher put it:
“The main development today was that the Fed really is not concerned about the move in core inflation, which the market is very worked up about,” said Stephen Stanley, chief economist at Amherst Pierpont Securities LLC
And another analyst completed the thought:
Powell has “seized the narrative back from the financial markets,’’ said Priya Misra, head of global rates strategy at TD Securities. “His message was growth is better and low inflation is transitory.’’
We happen to doubt the above bolded clause because there is considerable reason to believe that growth isn’t better and that inflation hasn’t dipped in any meaningful sense at all.
And while time will tell, the pertinent immediate point is that the whole episode is a crock—and one that sheds a spotlight into what is surely some kind of monetary Alice-in-Wonderland rabbit hole that has been confected by the Fed in the course of its deep dive into monetary central planning and inflation targeting over the last three decades.
Indeed, things have g0tten so tangled up in what has all along been seat-of-the-pants theorizing in the Eccles Building that now even the Fed heads can’t keep the inflation jello stationary.
Depending upon which index you squint at and for how long a time interval, you can always find a putative low-flation stat to justify more monetary easing, which is exactly what the Donald and his cheerleaders and the Wall Street punters have done ever since the Christmas Eve sell-off in the casino.
What this means, of course, is that financial markets can no longer do their real jobs of price discovery, as we treated with in the case of the trillion dollar Apple in Wall Street’s manic eye in Part 1 and will provide a lot more chapter and verse on Part 3.
Instead, the new low-flation excuse for easy money has turned the once and former testosterone-riven trading pits into the equivalent of a nest full of baby birds—their peaks wide open, always chirping for more from Mother Fed.
Of course, this blatantly self-serving chirping for still more stimulus and ever higher Fed facilitated asset prices gets gussied-up with a nod to a higher purpose. The basis point grubbing punters who operate down in the canyons of Wall Street had actually come up with a cover story for a rate cut that even sounded like patriotic duty or advocacy for the greater good of Flyover America.
It’s as if the Fed’s 2.00% inflation target had risen to the status of 70% homeownership, full employment, two cars in every garage and a Cornish hen in every pot—-to say nothing of motherhood itself. So they were hectoring the Eccles Building to rise to its public duty:
Traders are also in disagreement with the central bank and have priced in a so-called insurance cut that they see as necessary to get inflation back to the central bank’s 2 percent target.
Yes, and when is the last time that Wall Street ever gave a rip about the public good? And, besides, in an honest free market it is not even their job to care: The public good materializes when the invisible hand works its will.
Still, the insidious impact of inflation targeting is plainly evident in the very notion of an “insurance cut” that has been so prevalent among the talking heads in recent weeks. That’s because even if inflation targeting was not a financial toxin, why at this moment would you need an insurance policy on the 2.00% target.
Even Pusillanimous Powell made clear that there is no shortfall from target on an trend basis that involves something more than short-term squiggles. He cited the so-called Dallas trimmed mean CPI, which each month eliminates the 16% highest and lowest outliers from the basked of prices in the CPI. In effect, it removes the “transients”.
As Bloomberg noted,
Powell distinguished between price trends that might be temporary and those that would cause inflation to run “persistently below’’ the objective. He pointed to the Dallas Fed’s trimmed mean inflation index, which removes outlier prices on the high and low side. It stood at 2 percent in March.
Actually, the Keynesian monetary central planners—going all the way back to the original one, Uncle Milton Friedman—have always said that their policy ministrations, such as changing the funds rate or monetizing more public debt, work with a lag of up to a year or even more.
So surely you can’t measure inflation shortfalls by the month when “policy” functions by the year. That’s why we think the chart below puts a stake in the “insurance cut” folly. It consists of the Dallas trimmed mean CPI with its extraction of the transients, and is calculated as a one-year rate of change of the six months rolling average of the index.
As is evident in the chart below, this rendition of inflation at 1.97% for Q1 2019 is close enough to 2.00% for government work, and it’s about as smooth as the skin on a baby’s tokhes.
So unless you are hooked on some kind of spurious two-decimal place numerology, there isn’t remotely an empirical reason for an “insurance cut”, even if enforcement of the 2.00% target were a good idea, which it’s not.
The absurdity of inflation targeting is evident in the chart for the Fed’s favored PCE deflator less food and energy. In truth, it’s derived from the same raw basket of thousands of BLS collected item prices as the chart above—except it leaves the transients in, other than food and energy, which it takes out completely.
More importantly, it shows single month readings on a year/year basis, thereby eliminating the smoothing effects of the six-month rolling average displayed above. Not surprisingly, the baby’s tokhes above turns into a roller-coaster of volatility.
At the moment, the March y/y reading is 1.55349%, which is apparently what gave rise to the “insurance cut” idea.
Then again, nine months ago, the July 2018 y/y reading was 2.03842%. And if you scroll back to the beginning of the chart you get a putative low-flation emergency in June 2011, when the reading was 1.57583%, but in fact it wasn’t because six months later in January 2012 the reading was 2.12932%.
And so on and so forth goes the to-and-fro of the vaunted PCE deflator less food and energy. On the one hand, no one in their right mind would say that the Fed should stimulate on every dip and brake on every rip of the deflators’ short-run movement—especially because the braking part would elicit torches and pitchforks on both ends of the Acela Corridor.
Yet if you only “ease” on the dips you will end up doing exactly what both the casino punters and the Donald now so spuriously demand: Namely, rewarding Wall Street speculators and Fed front-runners who will hit the buy key whenever they see the juice coming, the fundamentals be damned.
Had the Fed actually capitulated to this recent bums rush on the “insurance cut” it would have made itself a pure tool of Wall Street greed and an engine of catastrophic financial asset inflation.
Nevertheless, the Fed’s policy of “patience” is still profoundly misguided—even if Powell has the common sense to be guided by the smoothed inflation chart above rather than the roller-coaster depicted by the monthly oscillations of the “transients” infused PCE deflator less food and energy.
That’s because there is absolutely no case in theory or history to suggest that 2.00% trend-line inflation is better for growth, jobs and main street prosperity than is 0.00% or even -2.00% for that matter. And, more importantly, a single central bank in one country—even one as allegedly omnipotent as the Fed— has no capacity to steer to the decimal places the rough
In part that’s because the inflation indices are crude approximations of true changes in the general price level, and are also a mixture of apples, oranges and cumquats in terms of the Fed’s ability to impact.
For instance, in theory the Fed should have more impact on the CPI index for services less energy services because their pricing is more subject to purely domestic conditions than global produced, traded and priced commodity and industrial goods.
Even then, there is the India Price for services that can be intermediated and delivered on the global internet, such as call centers, accounting, design, engineering, consulting etc; and then there is the whole problem of what are you measuring, anyway.
That it is to say, the job of measurement is hard enough for good like canned soup, where they keep shrinking the can and adding more potatoes to the claim chowder, on the one hand, or going up-scale marketing ultra-high quality premium offerings based strictly on organic ingredients and no sodium.
But when it comes to a Pilates session or even a hospital bed day or slot in a nursery care center—forget about it. The imprecision is mind-boggling because over any reasonable period of time consumers and suppliers are continuously arm-wrestling over price, quality, quantity and branded value.
Notwithstanding all of these hurdles, however, the way the BLS solves these dilemmas and measures services results in an index that has been trending way above the Fed’s 2.00% target for years, and at the moment clocks in at 2.75% on a y/y basis during Q1.
So on those elements of the price index that the Fed in theory can most directly impact, there job is done!
There is no low-flation in services and the index has been running above 2.5% for years.
On the other hand, here is the identical period since June 2012 for global produced durable goods and commodities of all types—energy, good, minerals and other materials.
The purple line for durable goods has actually been in a deflationary mode below the zero change level for virtually the entire period. But besides the fact that this is a wonderful thing for main street America’s hard-pressed (formerly) middle class households, there are two other features that are absolutely beyond the power of the Fed to impact.
To wit, part of the reason that durables have dwelled below the zero-inflation line for years is that the BLS keeps adjusting the index downward for hedonics (quality improvements) like air-bags in cars and faster speeds on your PC.
Fine. But whether those adjustments are warranted, accurate and comprehensive (it can be argued that a lot of deterioration in goods such as Chinese supplied toys and trinkets doesn’t get hedonically adjusted upwards), what does it have to do with monetary policy?
Why in the world should the Fed be attempting to inflate that which the BLS in its wisdom or folly, as the case may be, has chosen to deflate?
Beyond that you also have the problem that Keynesian central banking has spread to practically every nook and cranny of the planet. And that has fostered an unprecedented era of ultra cheap debt and investment capital (i.e inflated equity valuations) that has funded vast excess capacity to produce, process and distribute goods everywhere on the planet—but most especially in the Red Ponzi and its global supply chain.
That’s actually what’s behind the Donald’s ill-considered Trade War, but what it really means is that on a global basis the impact of cheap money central banking is deflationary on the price of commodities and goods. That’s because it puts new tools (factories, mines, cargo ships and computers) in the hands of the world’s still not yet exhausted supply of peasant labor.
The irony, therefore, of the Fed’s misbegotten commitment to 2.00% inflation targeting is that its own brand of globally propagated monetary central planning has produced an enormous deflationary wave in the markets for tradable commodities and goods.
So now it is supposed to pleasure Wall Street with cheap carry trade money and the automatic boost to asset prices which flows from QE and central bank bond-buying campaigns in order to countervail the very deflation that is central bank originated?
Needless to say, the same global story is even more apt with respect to commodities. During the last seven years of so-called steady global growth, commodity prices have been up the hill and down owing to many things, but especially credit cycles in the Red Ponzi, OPEC supply management maneuvers and the undulations of short-term global production, inventory and trade mini-cycles.
Moreover, you can strain out of the inflation index the gyrations in commodity prices simple by removing food and energy as does the Fed in its favored PCE deflator excluding these items.
Self-evidently, when the price of gasoline soars/plunges from time to time, households spend less/more at restaurants, ball games and Walmart’s, thereby cascading these effects through the PCE deflator ex-food and energy, anyway.
In short, inflation targeting not only has no basis in theory, it’s also lunacy in practice. It’s only certain impact is to create an enormous bias and powerful constituency for easy money—-the mothers milk of the Wall Street bubbles and fantastic asset inflations which are the real threat to economic growth, jobs and prosperity.
That is to say, the systematic and egregious financial asset inflation that results from Keynesian monetary central planning eventually collapse on their own weight despite central bank pivots, pauses and accommodations designed to keep the casino booming.
And we know now after two devasting bubble collapses this century, that it is the latter which trigger recessions by inducing stock option panic in the corporate C-suites and the violent liquidations of labor, inventories and assets that occur under the ruse of “restructuring”.
That’s the part that Jay Powell and his merry band of money printers don’t get or can’t admit. So they pretend to be vigilant looking for signs of “overheating” on the main street economy that will tell them, presumably, that the money spigot needs to be shut-off or at least dialed down.
Except. Except.
Just like there is no such thing as inflation in one country, there is not such thing as over-heating in one country, either. Given the massive global supply chains, excess capacity and logistics networks now in place, it doesn’t really matter a whit if the US steel industry is operating at 94% of capacity (it isn’t) because there is upwards of half billion tons of excess steel capacity in China alone.
Yet in his presser yesterday, Powell claimed to be looking for the hotspots in US industry that no longer actually matter much:
Sorry, Jay, your looking for your grandfather’s recession. But this is a global market with virtually infinite labor and massive excess mining, plant and transportation infrastructure. Industrial capacity utilization tells you nothing about over-heating on mind street—even as you are super-charging the bubbles on Wall Street which will bring the next recession to the front door of the Eccles Building before you even notice it happening.
As we said, what causes recessions is crashing financial bubbles. What needs to be looked at, therefore, is not the industrial capacity utilization chart above, but the lunatic stock prices of AMZN, Lyft, WeWork and a passel of other momo fantasies–a project we will take up in Part 3.