The markets continue to snooze
Although today we’ll get some news
But Home Sales don’t spark
A narrative arc
About which most folks would enthuse
 
As well, given all that they’ve said
Those dozens of folks from the Fed
The Minutes today
Are likely passé
So, markets will head back to bed

 

Another very lackluster session yesterday resulting in marginal equity gains in the US as the dearth of new information continues to weigh on trading volumes and overall activity.  Of course, the one thing we did get yesterday was another tsunami of Fedspeak but all of it was the same as what we have already heard.  There is no need to go into details but suffice to say that the theme remains, April’s CPI reading was encouraging, but not nearly enough to consider rate cuts soon.  Instead, while they all believe that inflation will continue to head back to their 2% goal (although none of them have explained why they believe that) it appears that the first cut is not likely to be warranted before the fourth quarter.  In fact, it seems that several FOMC members are lining up with a December cut in mind although the Fed funds futures market continues to price a 60% probability of that first cut coming in September.

But here’s the thing I don’t understand; why are they so keen to cut rates at all?  This is the actual language in the Federal Reserve Act as amended in 1977 [emphasis added]:

“The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.”

As is typical with legislation, there is no specificity as to what each of these terms mean and thus, they are open to interpretation by each Fed chair.  For instance, prior to 2012, the concept of stable prices did not have a numeric attachment, and, in fact, when Alan Greenspan was Fed chair, he explicitly mentioned that 0% inflation was indicated.  However, Ben Bernanke determined that in the wake of the GFC, a numeric definition would be appropriate and that is how we got the 2% target.

On the employment question, the economic concept of NAIRU (non-accelerating inflation rate of unemployment) had been the north star for the Fed for decades and that number had typically been estimated at 5% +/- a bit.  The concept is that there is a theoretical unemployment rate below which wage pressures will rise and drive inflation higher and above which the opposite will occur.  However, just like the Fed’s other imaginary friend, R*, NAIRU is not observable, and nobody knows where it is.  Recent indications are that it is at a much lower level than previously thought as evidenced by the fact that Unemployment (ignoring the pandemic activity) was able to hover below 4% without any inflationary pressures of note.  At least that was true until the pandemic response flooded the economy with massive amounts of liquidity and funding directly to the population via stimulus checks.  But, as I said, nobody really knows what that level is, and so the concept of maximum employment is extremely nebulous.

Finally, moderate long-term interest rates are another bridge too far for the Fed given its ordinary operations.  While the Fed clearly controls the short end of the curve via the Fed funds markets and its interest payments on reserves, the long end of the interest rate curve is a completely different story.  Certainly, QE was a direct effort to impact long-term interest rates and was quite successful at lowering them, although the definition of moderate remains missing in action.  For instance, a look at the below chart with data from the FRED database shows that the long-term average 10-year yield (my definition of long-term interest rates in this context) is 5.56%.

Source: data FRED database; calculations @fx_poet

With this in mind, the current level of 4.45% or so remains relatively low, not high, and so the idea that rate cuts are necessary to meet the Fed’s mandate seems disingenuous at best.  This is especially true given that inflation is still well above their target of 2%.  Unless there has been a complete sea change of economic theories at the Fed where suddenly higher interest rates are inflationary*, not deflationary, it seems that there is something else at play here.

In the end, my point is that Fedspeak, which is widely followed, usually highlights that there is no guiding star as to what they want to achieve.  As well, their definitions are apt to change quickly if there is a perceived political expedient.  However, I will say that at the current moment, it certainly appears the entire committee is on the same page and wants to cut rates but cannot come up with an excuse they believe the market will accept as real.

Essentially, this was all a preamble to today’s FOMC Minutes release, which given just how much Fedspeak there has been between the meeting and today indicates there is very little new information likely to be revealed.  In the meantime, markets overall remain quiet and rangebound with commodities the lone exception.

Equity markets overnight were mixed in Asia while European bourses are marginally lower (albeit still near all-time highs) and US futures are essentially unchanged yet again.  Bond yields are rising a bit with Treasuries higher by 3bps and European yields higher by 4bps with an outlier UK rise of 10bps after a much hotter than expected inflation reading this morning (3.9% vs. 3.6% expected) reduced the chance of a rate cut next month.  And finally, 10-year JGB yields broke through the 1.00% level last night although the JPY (-0.15%) is actually weaker on the news.

Commodities, though, continue to be the most interesting story around with oil (-0.7%) slipping further after a bigger than expected inventory build from the API data as well as news that the Biden administration is looking to release a portion of gasoline inventories into the market to lower prices ahead of the election.  In the metals markets, the big three are softer again this morning (Au -0.4%, Ag -085%, Cu -2.3%) although on the charts, all remain above key support levels.  It can be no surprise that they are consolidating after their massive runs of the past week or two.

Finally, the dollar is tracking Treasury yields higher with strength almost across the board.  The notable exception is NZD (+0.4%) which has rallied after the RBNZ, while maintaining interest rates unchanged, was far more hawkish in their commentary and indicated they discussed further rate hikes given inflation’s stubbornness overall.  But otherwise, ZAR (-0.8%) is the worst performer, which given the metals market moves should be no surprise, but the dollar’s strength is otherwise universal.

On the data front, as well as the Minutes this afternoon, we see Existing Home Sales (exp 4.21M) at 10:00 and then the EIA oil inventory data at 10:30.  Mercifully, there are no Fed speakers scheduled today, although I wouldn’t be surprised if one gets interviewed somewhere.

Rumors of the dollar’s demise seem badly overblown, and it remains tightly linked to the move in US yields.  Unless we see yields take a serious step lower, I suspect the dollar is likely to remain well bid overall.

Good luck

Adf

*As an aside, several years ago Turkish President Erdogan made this case and kept firing central bankers who wanted to raise interest rates in Turkey to fight their significant inflation problems.  At that time, the economics profession ridiculed the idea completely.  However, lately, there have been a number of articles published that have made the case Erdogan was correct.  Of course, that seems to be an effort to encourage the Fed to cut rates despite high inflation.  As of yet, this brainworm has not infected Chairman Powell, but who knows what will happen as the election approaches.