In the Trenches: Cake
June 19, 2019·1 comment·in the trenches
Markets are celebrating the prospect of rate cuts that historically precede economic contraction. The rallies are based on muscle memory from a decade of central bank stimulus, not on whether current conditions actually warrant action. This disconnect between what equity markets expect and what rates markets are pricing reveals something troubling about investor expectations and the Fed's grip on its own independence.
• The bet being made isn't subtle. Eurodollar futures are pricing an 80% probability of two rate cuts between June and December. Yet the economic data doesn't support preemptive action. This is market participants wagering that the Fed will cut because it always has, not because conditions demand it.
• The correlation is hidden in plain sight. The relationship between 10-year Treasury rates and ISM manufacturing suggests manufacturing contraction is coming. When it arrives, the Fed will have cause to move. The question is whether it moves before or after the data breaks.
• Central bank coordination looks different now. In 2016, coordinated global stimulus suppressed volatility quickly. Today, balance sheets aren't expanding, the ECB has stopped buying, and the Fed is still selling. Trade wars and political tension have replaced the post-crisis cooperation that made 2016 possible.
• The Fed understands something markets don't want to hear. Rate cuts implicitly transfer wealth from savers and credit investors to workers and equity holders. The Fed recognizes this happens largely without explicit legislative authority. This awareness has historically kept the bar for action high.
• The real tension is about institutional autonomy. If the Fed cuts preemptively in June simply because markets expect it and the White House wants it, something fundamental shifts about how central banks operate. The question isn't whether cuts are coming. It's whether they'll be forced or chosen.
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Comments
An excellent article from Mr. Cecchini. A lot of his conclusions and beliefs are ‘domestic cozy’ to me (to steal a term from Ribbonfarm.
I just have a hard time with one thing:
"I also do not believe that the current situation is analogous to the early 1970s when President Nixon appointed Arthur Burns as the Chairman of the Federal Reserve. While we will leave the reader to his or her own conclusions about the similarities between Donald Trump and Richard Nixon, it would appear that Chairman Powell is far less naïve than the academic, Burns. "
Hmmm…well your point is well taken. However, Powell may not be as ‘academic’ as Burns, but on the other hand he spent a lot of time at Carlyle Group, and has interests residing in making sure that PE and leveraged loans work and all his buddies and former colleagues are happy. Secondly, there are just so many signs that the ‘philosophical change’ that Mr. Cecchini cites as a precursor to a near term dovish set of expressions is underway and has been underway for some time. The Powell pivot, the new language surrounding ‘effective lower bound’, the reports about WH lawyers trying to figure out how to remove Powell under various circumstances. This all falls into Ben’s great advice “Ask why am I reading this now.”
Peter was bang on regarding no June cut, that made sense to me, but Fed Fund Futures also had that as a consensus bet.
The Fed has not cared about being redistributive, about hurting savers or about moral hazard for a long time, why should it start now? And while we can acknowledge the damage pushing the string harder can create, isn’t this the umpteenth act here? And there are easy narratives for the left or right to jump on to justify whatever they want. The right can talk about ‘well pensions are so wildly underfunded EVEN after an historic bull market, if it ends, game over’, and the left can do it through their version of populism and MMT type devices.
What shocks me is that the House Dems have not taken the Fed to task on the policies that have led to such wealth inequality. They are either a) too stupid/fragmented to make a circus of this with Powell in the center ring; (b) they are going to do this, but are waiting until we are T - x from the election; (c) they don’t want to double standard this too much, as they intend to push MMT like stuff. (a) makes the most sense to me, but I can see (b) happening later on. And (c) doesn’t make sense, because what politician cares about double standards.
Completely agree on the ZIRP forecast, but I think we really have to look hard about our preconceived notions of institutional integrity.
I wrote a little about some of these topics here ( www.thoughtxb.com ), though my writing cannot compete with ANY of the contributors at ET. Thank you and please continue to produce content like this.
-Wraith
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