Bullard tames the savage stock market beast

Outlook:

Housing starts are not exactly a big driver, but a gain in the Sept numbers today could be nice. The Bloomberg survey gets a rise of 1 million units annualized, from a 956,000 rate in August. Last year, starts averaged a 930,000 pace. A small issue: the National Associa-tion of Home Builders/Wells Fargo builder sentiment gauge slipped to 54 from 59 in September when surveys suggested no change, but do not despair—Sept had been the highest reading in 9 years and the index is still comfortably over 50.

We wondered the other day whether the Fed could or should say something to tame the savage stock market beast, and yesterday St. Louis Fed Bullard did exactly that. Actually, Bullard said only that the Fed should consider delaying the end of tapering in an effort to address falling inflation expecta-tions. "We have to make sure that inflation and inflation expectations remain near our target, and for that reason I think a reasonable response by the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent," Bullard said. "We could go on pause on the taper at this juncture and wait until we see how the data shakes out into December." Bullard said the 5-year TIPS had fallen to less than 1.5% and he is “worried about declining inflation expectations," something a cen-tral bank "cannot abide."

Some analysts say the equity market recovery on the Bullard remarks show mostly that players remain addicted to the spiked punchbowl.

The FT in its infinite wisdom writes “The remarks from Mr Bullard – up until now viewed as a hawkish member of the Fed’s Open Market Committee – helped counter worries that the eurozone’s periphery could be heading for another debt crisis.” What? This makes hardly any sense (and probably comes as a big surprise to Mr. Bullard). The connection between US tapering and a debt crisis in Europe is so stretched as to be almost invisible.

The FT goes one “Wall Street staged an immediate bounce – although it was by no means a straight-line reversal of early losses as the main indices oscillated between gains and losses. The S&P 500 finally settled unchanged at 1,862.” Elsewhere in the newspaper, the oil story quotes an analyst who sees the respite in falling oil prices as attributable to—you guessed it, Mr. Bullard. After all, “lower for longer” means stimulus to the oil guys, and lower interest rates are bad for the dollar, which should fall. “A low-er US dollar is positive for industrial commodities.”

Oh, dear. This is wrong in so many ways, it’s hard to know where to start. First, go back to Shep-ardson’s estimate that if oil prices remain low for longer, US GDP could be lifted by 1-2% over the next two quarters for a 4% annual growth rate. What was that German estimate again? On Tuesday, the Economy Ministry slashed the 2014 forecast from 1.8% to 1.2%. We get US inflation numbers next week, and while they may disappoint the Fed, they will not be 0.8% (Germany) or 0.3% (eurozone). In-stitutionally, the ECB wants to start QE and faces internal opposition, while the US is exiting QE. It doesn’t really matter all that much whether the US exits this month or next month or December—it’s exiting.

Maybe the equity guys see a spiked punchbowl for a little longer, but we say the only thing the Bullard incident illustrates is the deep hunger everywhere for less uncertainty. Confidence in central bank lead-ership and responsiveness is more important than the actual numbers. Bullard shows the Fed really is data-dependent. Now we get another dose of Fed-ness in the form of a speech by Fed chairwoman Yellen today at the Boston Fed. The topic is inequality of economic opportunity but everyone will be hanging on every word for more information on data-dependence.

This puts more importance on next week’s CPI, which will probably be a drop from 1.7% y/y in Aug to 1.6%. Eeek. This is not going to contribute to the firming of rate hike expectations and may push them out from end-June (“the summer”) to Q3. The FT has a pithy comment—it’s a replay of the taper tan-trum in 2013, when the bond market freaked out about the end of QE. At the time, Dallas Fed Pres Fish-er called it a victory for the “feral hogs” that the Fed retreated. Now is no different. Bullard calling for a retreat from ending tapering is capitulation to the feral hogs, again, especially in light of his earlier com-ments only a few weeks ago saying it would be risky to delay hiking rates.

To make matters worse, UK officials are lily-livered, too. “Andy Haldane of the Bank of England and the Fed's Eric Rosengren reinforced the dovish message on Friday. The former said he now favours de-layed interest rate hikes despite a UK economy in "fine fettle", while Mr Rosengren cautioned that "at this point we'll have to see whether the financial market turbulence portends something more serious".

The FT opines that “the Fed is wrong to back down in the face of the ‘feral hogs’ again. The sight of central banks in retreat after an arguably healthy correction is in the longer term bad for markets that have grown overly dependent on monetary tonic.”

We say the FT has an important point—no one likes a lily-livered central bank. And yet the Fed has been asserting it is data-dependent and not looking at data with preconceptions and bias. It is perfectly true that inflation expectations have fallen, and the Fed’s fear of deflation has just causes. So Ms. Yellen has a tiny needle to thread. Where does babying the market end and financial instability begin? Instabil-ity is an important topic, but no one has ever defined the criteria for a correction becoming so abnormal that it’s dangerous. The best person to hear from now will be the New York Fed’s Mr. Dudley. He’s the one who sees liquidity. True fear dries it up. As long as Dudley is happy, the rest of the Fed should be, too.

The US getting growth at 3-4% while the rest of the world languishes and inflation over 1.5% while Eu-rope is getting 0.3% (and both have a 2% target) can’t end any way other than favoring the dollar. Even-tually.

Note to Readers: We have jury duty next week on Tuesday 10/21. If we do not get a message Mon-day night that we are excused, there will be no reports on Tuesday.