Here’s how crazy all of this is: I can’t tell if the markets care what the Fed does

The Fed speaks with many voices

The Fed speaks with many voices, and most of those are egos with microphones. The Fed officials closest to the Chair and making up the governing majority speak rarely and carefully. Several regional Fed presidents would be better served not to speak at all (which was the case in the old days) — Bullard, George, Lacker, Mester, Plosser, Fisher, Kocherlakota…. A few of the regionals are extraordinary.

Eric Rosengren, Boston Fed, in August 2008 delivered the best single insight of the last decade. The Fed had been easing strongly both in rate and liquidity for a year, but credit markets seemed on a very dangerous path, falling out of the support by the Fed. Rosengren said that the deepening credit-market panic had “more than offset all Fed easing to date.” Nice call. Lehman and the economy failed the next month.

Rosengren spoke this week. He saw two conditions necessary for Fed liftoff: labor market improvement, which “has largely been met,” and second, “reasonable confidence that PCE inflation will move back to its 2% objective over the medium term.”
For that second condition, “the data have not been as clear cut.” Then, making him the first Fed official to acknowledge failure so plainly: “You might say the incoming data have not cooperated with the forecasts.”
He followed that with the zinger which tells us where we really are: “Nonetheless… we will reach 2% inflation if one sees the US economy as likely to continue growing above its potential.” Emphasis on continue is mine. Chair Yellen has used exactly the same phrase repeatedly. That’s the Fed saying current GDP growth in the 2-2.5% range is unsustainably too fast and the Fed intends to lean against it, the only question how soon and how hard. Everyone I know feels as though the U.S. is just pooping along at stall speed, the economic quality of life improving for less than one-third of us.
But the Fed is utterly focused on the Phillips Curve — the inflationary effect of a too-low unemployment rate. Even if wages are growing too little now, upward tension is accumulating. Rosengren did recite his doubts about overheating, again the only Fed official to note “indications of a much weaker global economy.”

Rosengren’s conclusion gives us the first clear long-term forecast. The Fed’s 3.75% as the long-term target for fed funds is not normalized in the sense of open-ended stability, but the endpoint of a tightening cycle resulting in the recession necessary to raise the unemployment rate from the Phillips inflation danger zone. Rosengren’s analysis uses three years from the first tightening to the end, a historical pattern, although from 0% today a very low slope.
Whether the Fed lifts off next month is immaterial. Rosengren gave us the plan.

I can’t tell if the markets care what the Fed does

Here’s how crazy all of this is: I can’t tell if the markets care what the Fed does. The Fed has its plan, but markets are properly mesmerized by an outside world falling apart, not a mere cyclical deterioration soon to turn, but structural. Every central bank ex-U.S. is hosing cash into local economies with all the effect of transfusing a patient who has an open artery in the other arm.
This holiday weekend take time to give thanks for the exceptional flexibility which has allowed the US the luxury of low-slope recovery and a threatening Fed, and thanks to the rest of the world for sending money here to keep our long-term rates low.

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U.S. 2-year T-note two years back: tops in yield in the last year are all in the same place, thus pricing no Fed tightening after the first move. That’s an excellent measure of how very surprised markets will be if the Fed tightens a second or third time.

U.S. 10-year T-note two years back. Could as easily go lower as higher, no matter what the Fed does: