Fed raises funds target from 0.75%-1.00% to 1.00%-1.25%. Next!
Next maybe, but when? There were two stories unrolling yesterday with the markets all atwitter following some pretty soft-looking US inflation numbers for May popping up on the open. Forecasts had been for core CPI to report at 0.2% month-on-month and for the annual inflation rate to come in neatly at 2%, bang on the Fed’s target. In the event, the figures read 0.1% and 1.9%, respectively.
Analysts were quick to point out that the unexpected softness had been the result of a fall in the cost of mobile telephony and prescription drugs. Thus, unless one were either sick or had just renewed one’s cellphone contract or, ideally, both, one’s personal inflation would have been well within the inflation target.
The Fed has no reason to be swayed by any month-on-month reading and more importantly the Fed funds rate is still below inflation and thus the quite destructive phenomenon of negative real returns persists. Negative real returns, as the developments in Japan over the past 20 years have proven, do little to encourage consumers to spend money they have rather than money they haven’t.
TIGHTS DOWN
Yes, the lack of inflation is troubling but the past months and years have shown quite clearly that persistently low interest rates are just as much, if not more, part of the problem as they are of the solution. How any rational economist or market strategist could suggest that with inflation at 2% or thereabouts, the monetary authorities should feel compelled to delay imminent tightening moves or diverge from an ongoing tightening cycle as long as the big figure on rates is a 1 defies me. If GDP growth were negative – in the old day we used to call that a contraction but I don’t want to be a grumpy old man – it would of course be incumbent on the Fed to push rates lower, faster but we are in what has been reported as the third-longest period of persistent GDP growth since World War II.
I have argued in the past that the population as a whole is a net saver and that the positive wealth effect of increased returns on savings and investments would go a long way to stimulating consumption. Sure, as professionals we all understand the concept of total return but for most people, although the capital value of their portfolio might excite them, at the end of the day it is the income stream that will determine their economic behaviour.
With all due respect to Janet Yellen, she apparently “gets it” a lot more than those journalists who were quizzing her at the post-meeting press conference and if one listens to the answers rather than the questions one learns a lot. Fed balance sheet reduction is announced but with absolutely no timetable attached. Add that vagueness to the statement in the March minutes that the Fed has no qualms about reinvigorating bond purchases if needed and one ends up with the conclusion that QE is neither over nor a temporary measure but here to stay. The Fed, along with its peers, has found a way to manipulate at will the entire yield curve and that is not a power it will give up lightly.
Sure, the “caps” for reinvestment of redemption proceeds were reiterated but as is right and fair, there is nothing committal in the rhetoric and the FOMC reserves the right to do absolutely nothing, if it so chooses.
Comparing the fresh with the last post-meeting statements, as is my wont, it is clear that the morning’s softer-than-forecast inflation numbers had more effect on skittish markets than they did on stoic FOMC members. As I predicted yesterday, there were no fireworks and Madame Yellen told us nothing we didn’t already know. I recall that at the beginning of the year market consensus was for two rate increases in 2017 against a minority, myself included, who had plumped for at least three hikes. There are six and a half months left to go and two of the hikes are already on the board. I wonder how many of the two-move proponents would still be prepared to put money on the Fed being done and dusted for 2017?
THE NAKED TRUTH
Meanwhile Greece is in the news again as the prospect of a solution to the current gridlock seems to be in the making. In July the country has to repay €7bn that it clearly does not have. There is much talk of Athens having now met the conditions that were necessary for it to see the release of the third and final tranche of bailout money. I’m not quite sure where the Eurogroup buys its rose-tinted spectacles but I’d love to own a few pairs myself.
The debt relief issue remains the final stumbling block and German finance minister Wolfgang Schäuble persists in refusing to crumble on the subject. Talk remains that debt relief is sought in order to make the €315bn the country owes “sustainable”. Other than by way of a near-total writedown of the debt mountain, that will barely ever be the case. Schäuble sees himself as the little boy with his finger in the dyke. Greece sees itself as Little Red Riding Hood, Schäuble as the wolf and the IMF as the friendly forester. All I can see is a naked emperor who thinks he has a smart new suit of clothes.
Overnight markets in Asia and particularly in Australia didn’t look too clever and Europe is very much on the back foot today. At least once a day one can read some comment predicting the mother of all stock market crashes is near. I stick with my view that as long as dividends continue to outstrip coupons, the risks remain contained. Based on what the Fed and the ECB are telling us, that changing is not imminent. Stay long.