Fed won't set off a straight line run to steadily rising rates

Outlook:

The important event today is the 2 pm FOMC statement. The consensus has it that the Fed will say nothing of any use in helping us guess whether September is a feasible date. After all, the Fed wants to wean us off dates and onto data. We will hear wishy-washy things about growth and the job market, with the big deception coming in whatever the Fed says about inflation.

Despite some rumblings from the Cleveland Fed and others, the Fed’s official data does not show infla-tion that would justify a rate hike, and that’s existing data from before the latest round of oil price declines. Granted, the Fed looks at a core number ex-food and energy, but never mind. Energy costs pervade every blessed good and service. The Fed persists in saying it is “reasonably confident” inflation will rise to reach the 2% target sometime in the ever-farther future, but honestly, the assertion lacks credibility. See the chart.

And yet holding rates at or near zero since December 2008 simply has to stop. Enough already. Normali-zation will bring benefits we have yet to identify in any specific way, including the sigh of relief that the crisis really is over and we can and should turn our minds to other things. Those still suffering from foreclosure and part-time jobs and the minimum wage need to see a light at the end of the tunnel, as do captains of industry sitting on $2 trillion of cash.

Unfortunately, it’s not hard to find reasons to delay. Today one of the main economics stories is that wages are failing to keep up with house prices, homeownership rates are at a 48-year low, and to make matters worse, the drop in health-care costs may be about to end and the costs start zooming up again. Raise interest rates and the housing situation doesn’t get better, and to raise rates on rising inflation in a single sector makes no sense at all. Besides, the dollar is firm and likely to remain so, cutting inflation from imports, while external events like Greece and China have no place in analysis of the US domestic economy, which is, after all, the Fed’s mandate.

We guess that wages failing to keep up with house prices is more important than the last jobless claims number hitting the lowest number since 1973. It just doesn’t pass the “So what?” test. And yet the job market is the Fed’s central focus. Yellen and other Feds note that while headline numbers look good, underneath the job market is rotten—low participation rate, part-time jobs, etc. The important point is that keeping rates at zero has nothing, or almost nothing, to do with the structure of the job market. The structure is beyond the Fed’s grasp. That doesn’t mean the Fed won’t continue to try to influence it with the only tool it has.

So, on the basis of both employment and inflation, a hike is not justified. We also fear the Fed might be distracted by Congressional intrusions and other details, including the stock market and whether there will be a liquidity crisis in fixed income when the First Hike is done. The biggest worry is that the Fed values its reputation more highly than the benefits of normalization and would defer a hike just in case the economy slumps again and it has to take rates back to zero. The perfect is the enemy of the good.

So, whatever we get from the Fed today, don’t count on it setting off a straight line run to steadily rising rates. The bond and FX markets don’t see it that way and their judgment has been pretty good.

On another front, all is not well in the eurozone. One of the key goals of the EMU was to get conver-gence in central economic measures, mostly inflation, in order to halt destructive competitive devalua-tions. The French were the masters of beggar-thy-neighbor “mercantilist” policies. But a lot of the con-vergence trumpeted in the early days of the eurozone was illusory, temporary and badly measured. Now the ECB says "Progress towards real convergence among the 12 countries that formed the euro area in its initial years has been disappointing." According to Reuters, “Central European countries have made significant gains but early adopters of the euro cemented their poor institutional frameworks, leaving them vulnerable to shocks.” This affirms the joke that the eurozone is better for Bulgaria than for France.

Macro musing is always fun but honestly, it’s not useful in near-term FX forecasting. The euro went up for reasons we never found out and today is going down for the same unknown reasons, from which we deduce big players are re-positioning for reasons they do not disclose. Some of it could even be to hose the amateurs. We will believe in the end of the euro rallyette when it surpasses the last intermediate low, 1.0922 from July 24. It “should” break the level, but that doesn’t mean it will.

Note to Readers: We will not publish any reports the week of Aug 3-7. Cape Cod beckons.