FED Inflation and the Dollar
17 Jun 2021 ● 03:07 AM
The FEDs overnight action needs to be looked into from three different lens
1. What the FED did
2. What the FED communicated
3. What the news communicated
The news did what it always does, choose from all of the above what best explains the day's market movement. The Dow was down 265 points and the news services believe that it is their job to explains why that happened. So they do not really listen to what the FED actually does. So they picked on the possibility of a rate hike in 2022 based on the "Dot Plot", a name given to the committee members' forecasts for interest rate hikes. These forecasts have historically been ignored by the chair while making rate decisions, whether it was Bernanke or Yellen, they went on doing what they wanted to do without much regard for the dot plot. At the end of his statement, Powell stated that the outlook is not a signal of the future course of the policy, as no one knows where the economy will be in the future. But who cares, that was the only piece of data that the media could hook onto to explain the market's decline and appear technically correct. Done
Now Powell was to acknowledge higher inflation and give us policy direction to deal with it. But unless you heard it in so many words, he communicated that he still thinks it is transitory. This was what I was expecting to hear because of all and more of the reasons he mentioned.
1. Inflation is caused by the lag in transmission of higher oil prices into producer prices. True but really why are oil prices up more than 10 times in a year? From the crash to single digits Oil prices were supported by sanctions on IRAN oil exports and an OPEC and Russia deal on production caps. That tight market has been kept into the reopening from the lockdowns that has seen us go from overflowing tankers to tanker shortages. So was this driven by Monetary Policy?
2. Inflation is up because of supply-side bottlenecks. True, some of the bottlenecks are caused by the lockdown but others are now caused by labor shortages. We are witnessing a record number of "unfilled Jobs" that are job openings that have not been taken up. Reason? The stimulus checks offer a higher wage rate than the market rate disincentivizing people from going back to work quickly and thus resulting in lower output or production of goods that are being demanded by consumers due to the reopening. So the same money is acting as demand for goods and restricting production? Blame the govt but not monetary policy. This will of course go away after the checks stop going out. Yes, it's transitory, but what has this to do with Monetary policy?
3. He did not mention Food prices going up due to droughts in California and Brazil. Now that can only be solved by the rain gods next year.
Yesterday we heard that China wants to sell some of its commodities into the market to keep prices from going up. I hope you remember the news one year ago. In the depth of the depression, China was buying commodities that it might need later for building infrastructure. So they were hoarding it. Now that action was supposed to help us get out of the depression by creating some inflation wasn't it, just like OPEC's actions.
If all of this is true then what does it have to do with monetary policy. All of the above are then transitory and nothing to do with Monetary policy. There is a saying among some economists that all of the inflation no matter what is always a Monetary phenomenon and many want to blame the rising prices on the FEDs QE. But the reasons above do not show any such linkages. QE 1/2/3 all failed to work anyway. What has worked has been direct intervention in the commodity markets by governments or bodies that control supply. Add to that the announced move towards green energy for some icy topping to sweeten the speculation.
So the market's expectations that raising interest rates will solve the problem are also misplaced. It will bring down inflation for sure but at a very large cost and with a direct attack on debt that had nothing to do with any of what transpired in commodity markets over the last year.
So going back to point no.1 what did the FED do? Nothing, no rate hike, and QE at 120 billion dollars per month to continue as it is, till it achieves its goal of full employment. It also expects that inflation will fall back to 2.1% next year after the transitory effects go away and base effects kick in. It will only consider monetary policy aimed at inflation if the inflation animal proves to be something else than what is currently expected. In short, it said that it is nowhere close to considering raising rates or reducing QE, and will let you know well in advance. The same thing it said many times before but in more words, enough to confuse the algorithms that only read words of speech to place buy and sell orders. What the FED did do is touch IOER rates that are meant to absorb the excess cash at banks that were written extensively about, and with that, it will not result in QT as was widely speculated.
So the Algos pushed up the dollar and down the bonds. Now big moves in these markets on FED/ECB meeting days are not new and often the move gets covered in the next 2 days so there is no reason to jump the gun on any conclusion. Wait and watch.
Technically the dollar index below bounced in wave 2 and that bounce has now gone in one day from 23.6% to 50% retracement. But that does not change that it is wave 2 up and wave 3 down is next. We are just going to have to wait for it.