June: The Trifecta For Policy Error?

In about 30 days the Federal Reserve will hold its scheduled June (13-14) meeting of the FOMC to either give a thumbs-up, or thumbs-down to increasing interest rates in earnest once again. The odds that the Fed. will indeed raise again now stands at about 99%. In other words – it’s all but a near certainty.

With that said, one can’t help but marvel at not only the “markets” sheer abandonment on volatility with such a near certainty on its doorstep. But rather, the only thing to rival it is the sheer arrogance being displayed by the Fed. itself that such another increase is warranted as every data point to a self-professed “data dependent” consortium is not just flashing, but screaming danger with every passing day. e.g., B.E.A. Q1 GDP 0.7%, Atlanta Fed. GDP Now™ 0.2%, JPM Cuts Q1 GDP to Just 0.3%, and more.

In days of yore (i.e., Ancient history circa 2016) whenever the odds of hiking approached anything like the levels they do now, the Fed. would take to the media in any manner possible and try to supplant soothing tones of, “Hush now little ones and not too worry…” as to make it evidently clear the Fed. had no such intentions going into their next meeting. After all, as history has shown time, and time again, just the “idea” that a rate hike could be imminent sent the markets reeling needing for an ever incessant response of one Fed. official after another to shout, “Don’t worry! We’re here with ever more potent QE should the need arise!” i.e., This is why we now have such a thing being worthy of its own moniker. e.g., “Bullard Bottom.”

Today, the exact opposite is the case. Not only are there not any soothing tones, but rather, there are tones emanating from what can only be described as an outwardly defiant, all seeing, ever proficient collection of “Hawks Are U.S.” for any and all questioning.

As an example: In what can only be taken at first glance as a “Wait, what?” moment. The New York Fed. has concluded that the more than $500 TRILLION dollars (and rising – again!) of O.T.C. derivatives outstanding remain (wait for it…) “an important asset class.”

For those of you having that “Wait…what?” moment as you’re reading this and just can’t remember why your brain just froze from the absurdity of such a statement? That’s because “derivatives” was that phrase you recalled as the center for every reason which caused the great financial crash. (For those of you wanting more on this topic, I highly recommend this succinct breakdown by Wolf Richter of Wolf Street™.)

So why is the above important other than it’s “ticking time bomb” factor? (As if that isn’t enough.) No, the reason why it stands out for me is how it’s viewed by members of the Fed. itself. i.e., “Don’t worry, we got this!” And here’s the reasoning…

If it’s now on the books (see above) openly stating its acknowledgment with its size and scope, along with, that the Fed. itself sees it as an “important asset class?” That makes the case (or allows for it) that the Fed. itself not only allowed, but rather, with eyes-wide-open helped facilitate its further ballooning. Hence: If (or when) it “pops” the Fed. has no one else to blame but itself (along with the potential hordes carrying “torches and pitchforks”) for they have now openly stated (again, and inserted it into their report) they not only knew of it, but rather, considered it as an “asset class.” e.g., Giving it their blessing and endorsement.

Remember how that other all important “derivative” class of assets backed securities worked to facilitate the “Great Financial Crash?” Hint: CDO, MBS, CDS, just to name a few? That too was another “We got this asset category.” Feel better?

The real issue that sits squarely in-front of the “markets” is the realization that the entire “reflation” trade may in fact be D.O.A. much like the legislation that was supposed to foster its existence to begin with. Let me put it this way since we’re talking about “derivatives” and their potential for highly correlated monetary wealth destruction vehicles.

The “reflation” trade that is now omnipresent in the “markets” which has facilitated the non-stop rocket-ship ride since the election of Donald Trump is nothing more than a “derivative” vehicle (or expression) of the underlying legislation that was to be its foundation or “backing asset.” e.g. Signed into law legislation.

In other words – If the legislation (i.e., tax cuts, Obamacare repeal, et cetera) don’t become signed into law legislation amounting to precisely what the “value” of those cuts and more represented (i.e. $1 TRILLION in infrastructure, Obamacare total repeal equivalents, massive corporate tax restructuring et cetera) the entire run up from Nov 2016 to today becomes de facto null and void. e.g., The “derivatives” (as in the profits made) based on “the trade” become? Hint: It’s not good.

The only thing that could (or will) make matters worse was if the Fed. had raised interest rates in anticipation. Again, hint: Not only have they raised, they’ve raised twice, and looking to raise for a third. All into further deteriorating economic data.

To re-emphasize just how precarious the “market” now sits, below is a chart I feel puts it into perspective. To wit:

(Source)

As one can see, that red rectangle represents the turmoil the “markets” had portrayed once the QE “IV tube” for all monetary woes was removed. Again, not only did the “market” suddenly halt its ever-ascending journey, but it suddenly produced ever-increasing bouts of near-death experiences needing ever the more dovish tones from the revolving cast of Fed. speakers hitting the media in ways that would make a Kardashian envious.

Again, for I can’t mention this enough, right before the election in October 2016 the economy was on such shaky footing (and as the “markets” were rolling over once again) the Chair of the Federal Reserve gave what I call her most contradictory speech when juxtaposed to today’s raising into weakness stating (paraphrasing): Running a “high pressure” monetary policy may be the only way to heal the damage still residing within the economy via the crisis. An “ultra-dovish” insinuation if ever there was one.

And yet, as the above shows, just 30 days later with the victory results of Donald Trump now into the books the Fed. morphed into “Hawks Are U.S.” and have been ever since.

I made note of this and was subsequently mocked via the mainstream business/financial media as something that “Ain’t gonna happen” using the prior 2 years as evidence. i.e., Directly after the meeting most analysis was, “They’ll probably not raise again till mid year, if then.” Then, all the jawboning for more began in earnest via one Fed. official after another including “balance sheet reduction.” Then March happened, and now June is about too. Here’s what I wrote in Dec. of that week. To wit:

“I implore you not to solely take my word, but to watch the presser for yourself and draw your own conclusions. I believe it’s one of the most forceful expressions made, or conveyed by The Federal Reserve that it may in fact act aggressively via monetary policy should it decide – It (“It” being the Fed.) seems fit. i.e., The implications seemingly being sent are that they’ll decide what a “good” economy is – fiscal implications be damned.

Now is where “fiscal implications be damned” might be far more relevant than the Fed. (as well as “markets”) ever imagined prior. The reasoning?

All that “fiscal” seems to now be damned to not seeing the light of day as far as 2017 may be concerned. And that’s something I feel the Fed. hadn’t calculated into their conclusions. (never-mind the “markets”) After all, with both the House, Senate, topped with a president all controlled by the same political party; how would legislation not be passed swiftly? (Although many others wonder that exact same thing, but I digress.)

However, with that said, the economy was/is in no shape (just using the “data” we’re all told influences a supposed “data dependent” Fed.) for incessant hawkish jawboning followed up by raising twice within 90 days. Again: All while arguing (and allowing the inclinations to be held via the futures fund) that indeed the Fed. is “hell-bent” on raising once again – in June!

That would be 3 raises in all but 6 months with balance sheet reduction arguments still front and center in Fed. communications when speaking in open forums. Are you beginning to see the implications for “policy error” more clearly?

I’m sorry to keep repeating, but it’s something which can not be repeated or stressed enough: With further deteriorating GDP and other metrics, along with no fiscal stimulus possibly seeing the light of day (meaning actually signed into law) for the rest of 2017, along with a potential government shutdown and more. June is now to be considered (as via the Fed. not saying or refuting anything to the contrary) a done deal? And a prudent one at that?

Oh, and for those who may want even further examples for contemplation? Here’s just one of the items that can be classified under “and more.” Hint: China.

But not too worry, for if you listen to current Fed. officials and their assessment of global economic conditions, you know, where the “reflation” trade is the “derivative” of the underlying asset of passed legislation (which has gone from “passed” to all but DOA) that the entire recent run up is based on?

“They’ve got this!” Just like they’ve got those other “derivatives” under their watchful eye. So June is now a shoe-in.

Feel better?

© 2017 Mark St.Cyr