2015/12/16 Commentary: Fed’s ‘Normalcy Bias’ Continues (late)
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COMMENTARY (Non-Video): Wednesday, December 16, 2015 (late)
Commentary: Fed’s ‘Normalcy Bias’ Continues
We have already explored this topic at some length in our Will 2016 be 2007 Redux? (‘Redux’) post (back on Tuesday the 8th.) There are many other reasons why headwinds will be strong enough to present significant challenges to the global economy and equities in 2016. And in spite of Fed Chair Yellen’s assurances that inflation would rise on the back of a strengthening US economy, the Fed raising rates beyond Wednesday’s ‘liftoff’ from the longstanding ZIRP (Zero Interest Rate Policy beloved of Ben Bernanke) is problematic at best.
And much of the problem with the seemingly still ‘gradualist’ rate increase view is that it doesn’t make sense. Not from the Fed’s projections, or in some ways even from the FOMC statement (in our lightly highlighted version.)
In the very minor first instance the 25 basis point hike will raise short term credit card interest rates to the consumer. And the banks have already made clear that in a global savings glut (see Redux on that), there is no incentive to raise deposit rates. This is small potatoes to be sure. Yet it indicates how even though this single move does not impair the outlook, the extended implications are not good.
As also covered at some length in ‘Redux’, The Fed is trying desperately to restore a sense of ‘normalcy’. It hopes the public and markets agree. However, as noted previous, if getting back to ‘normal’ means the ‘new normal’ it is less than propitious. That could be an environment not capable of sustaining higher levels of consumer activity in the home of conspicuous consumption. And that is six years into the ‘recovery.’ If things fizzle now, it does not bode well for the global economy.
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▪ There are many other factors which are even more daunting for the US and global economies into 2016. However, as we already explored those extensively in Redux back on the 8th, we will not burden this targeted evolution of the Fed’s ‘Normalcy Bias’ with discussion of those many other factors. Some of them are even more daunting than any Fed interest rate increases. Especially the OECD semi-annual Outlook contains some significantly troubling factors. We suggest a read if you’ve not done so already.
What is ‘Normalcy Bias’?
‘Normalcy Bias’ is a classic psychological syndrome where the impact of a pending disaster is not acknowledged due to the desire to think everything will be back to normal in spite of signs to the contrary. The Fed repeatedly communicates it is confident inflation will push up further any time now. This seems a lot like ‘whistling past the grave yard’ in the face of recent further commodity price declines.
A classical example from the real world is folks who remained in seats after a 1977 airplane crash in the Canary Islands. The plane was still on the runway with the top of the cabin shorn off by the other jet that had already erupted into a fireball. In spite of ample opportunity to flee via openings in the fuselage, only 70 passengers released their seat belts and managed to get to safety. The remaining 426 passengers remained in their seats, possibly waiting for instructions. They perished when the fuel tanks exploded.
Researchers have found that in a large looming disaster only 15% or so of people can react. The rest remain frozen in place. Similar reaction (or lack of it) accompanied stark warnings before 2005’s Hurricane Katrina hit New Orleans. Many people were assessing how it would compare to other storms they had weathered in place instead of pursuing an exit plan.
And the obvious warning signs on the way into the 2008 global equity market implosion was another good example. How many indications did people want on banks and securities firms hiding toxic MBS off balance sheet before they understood the system was bankrupt? Yet most folks listened to analysts who counseled things would be OK.
As we have noted quite often, all of the talk of returning the world to levels of inflation that speak of the need to invest has put the cart far out in front of the horse. Enlightened policies from structural reforms should be encouraging investment and hiring. That would naturally create some real inflation.
Central banks’ attempts to give the illusion of health through manufacturing some sheer monetary inflation during a sustained weak economic period is Voodoo Economics. It also appears that it is failing miserably, as indicated by weak commodity prices and lackluster employment (compared to the normally robust recovery from a deep recession.)
More Mindless Across Time
And in this case the Fed’s continued assertions that it expects “conditions to improve” consistent with the return to 2.00% inflation very soon seems more mindless across time. And even the US Employment reality is less impressive than headline US Non-farm Payrolls would suggest.
One of the folks who is a longtime Democratic operative and administration expert is University of Chicago professor Austan Goolsbee. In spite of issues with some of his views at times, he has very strong credentials. He was a senior adviser to Senator and then President Obama both in campaigns and on the Council of Economic Advisors.
His CNBC interchange with the American Enterprise Institute’s Kevin Hassett was most interesting. He was very pointed in observations on the US labor market being too weak to justify the Fed’s liftoff from ZIRP today. In a more concise manner, he made many of the same points we had used in Redux. That is especially on the US Employment growth not being equivalent to previous eras when wages were higher. Professor Goolsbee estimates that at current lower wage levels the Unemployment rate would need to be near 4.0%% to justify a rate hike.
Inflation versus Rates
The Fed’s own projections speak volumes about the underlying lack of inflation. Note the data that accompanied the statement and Janet Yellen’s press conference. The rate forecast posted here certainly appears to be one that justified today’s liftoff from ZIRP. The Fed also strongly asserted that it needed to move now. That was to avoid a more aggressive rate hike cycle later if it became clear inflation was indeed rearing its ugly head. Yet there is little in the Fed’s inflation projections that justify the interest rates seen at those future horizons. Not unless the economy is so strong the Fed was overtly attempting to slow it down.
Yet Chair Yellen made it clear that moderate US economic growth was only going to create a gradual return to inflation. Even that seems like hyperbole under the circumstances. The Fed’s inflation projections are as follows for December of each year:
2015: 0.40%; 2016: 1.60%; 2017: 1.90%: 2018: 2.00%
First of all, expressing a view that inflation will reach the Fed’s 2.00% target across time, and then indicating it will take three years does not inspire much confidence. Secondly, the rates table would seem to indicate the Fed is expecting to impose real positive short term interest costs on the economy in 2017. Interesting if the Fed is expecting economic growth to remain strong into 2018.
Oh! But that’s right… it’s not. The ‘central tendency’ for US GDP growth is expected to average 2.10% for 2015, rising to 2.40% in 2016. Yet it is then expected to weaken back to 2.20% in 2017, and slip back to 2.00% in 2018. Given the inflation projection and the potential for the economy to be weakening already in 2017, why is there a need for a 3.25% federal funds rate in 2018?! More Voodoo attempting to convince the masses and investment classes that things are getting back to ‘normal’?
Most incredibly, Yellen characterized the later phase as dropping back “down to the longer run growth rate.”??? We repeat, “???” Have the Fed and our other leaders been so unsuccessful that we should believe a US economy that barely gets to 2.40% GDP growth rate is ‘above trend’? Stop and think for a minute about how that fits in with her assertion that the US growth is going to cure the problems of emerging economies by leading them higher.
Jim Grant
While markets do not always conform to any pundit’s near term views, one of the people we respect for in depth understanding is Grant's Interest Rate Observer founder Jim Grant. As luck would have it, was a guest on CNBC after the FOMC decision and Chair Yellen’s press conference. It was a very interesting conversation, especially from approximately 2:30 into the clip.
His assessment is something we have mentioned as a possibility for some time regarding the Fed’s pressing need to get off ZIRP to provide a sense of ‘normalcy.’ He noted that today’s Fed move was likely a policy error in the current global context. Being far more talented in the area of economic projection that us, he was even willing to put a percentage potential on the rate hike being reversed as the Fed’s next move. He puts it at “between a quarter and a third”! That’s quite a statement, and reinforces our previous indication that this hike might in fact be a ‘policy error.’
While he is not considered as much of a Cassandra as David Stockman (who we referenced in Redux), he was very pointed in his criticism of the massive US Quantitative Easing program. Finally! Someone with his analytic prowess who reinforces our long held view (going back to summer 2012) that QE cannot create a return to robust growth.
Conclusion
Top line of the conclusion is that there is a confluence of factors that are less propitious for the continued growth of the global economy than the powers-that-be would like the masses and investment classes to believe. The bottom line is that all of the talk of returning the world to levels of inflation that speak of the need to invest have put the cart far out in front of the horse.
Only structural reforms the political class has stubbornly refused to even attempt can restore real growth. And only that will bring real inflation instead of sheer monetary inflation by which the central banks are attempting to trick the public into believing things must be returning to better times.
Yet the ‘Santa Portfolio Manager’ rally season is in full swing. (Note the equities activity since Crude Oil rebounded on Monday.) So the Fed’s hike being a phony sign of strength might not weigh on equities in the near term. However, market activity across time into next year will be the real measure of both economic data and markets. That obviously includes the govvies as well. They should be strengthening again if we are right.
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