Fed's credibility is already in tatters?

Outlook:

We expected the Fed minutes to deliver nothing by way on new information or insight, and nothing is what we got. The Market News fixed income reporter says participants are hopping mad at “communication” that delivers no real information. They wanted to know, specifically, what made the Sept decision a “close call”--but didn’t get the reason, at least not explicitly. The conditions for life-off are mostly met or will be, probably, but downside risks to the economy are higher at the same time. Huh?

One analyst (Amherst Pierpont) said "the Fed's credibility is already in tatters. Market participants have concluded that the Fed is going to find an excuse to extend super accommodative policy for a very long time.” The WSJ survey shows 64% of respondents expect the hike this year, but what economists think and what practitioners think are two different things.

And nobody knows what to make of the high number of references to the dollar, twice as many in the Sept minutes as in the July minutes, according to Bloomberg. So what? The Fed doesn’t make dollar policy—the Treasury does. And the Treasury doesn’t actually have a dollar policy, anyway. Think of the last time anyone at Treasury mentioned the dollar. We used to get “a strong dollar is in the US’ best interests” (Rubin) and “let the market decide” (Snow). Neither can be named a “policy.”

At a guess, the glancing attention to the dollar is due to Fischer’s influence, but again, so what? We do not expect the Fed to make policy with its effect on the dollar as its first consideration, or second or third or fourth, either. The other Anglo central banks do consider currency levels—UK, Canada, Australia, New Zealand—but policy per se is set by domestic conditions and the currency jawboned rather than targeted by rates.

Besides, the Fed considers the dollar a temporary, transitory factor, like energy prices, and like energy prices and stock markets, not something it can “manage.”

If we get to year-end without action, it’s all over for the Fed’s credibility. Many think it’s impossible for conditions to improve enough in just two months to make a difference. One analyst says that if payrolls comes in really, really high for the next two releases before the Dec meeting—over 200,000 both times—there is a tiny chance that Yellen statement of “this year” could be true. But not really likely.

The Market News reporter doesn’t say so, but upcoming auctions might be in trouble. Who will want to buy paper that dips underwater right away? “In other action Thursday, the Treasury market tried to do better but it did not do a good job of it. And now all three of this week's auctions are underwater. The 3-year was awarded at 0.895% on Tuesday and it hit a high yield of 0.957%. The 10-year sold at 2.066% on Wednesday and hit a high yield of 2.12% on Thursday. The $13 billion reopened 30-year was a bit of a head fake but turned out similar to last month's auction where customers took what they wanted and then said ‘okay, no more.’ The when issued note was trading at 2.919% into the auction and it was awarded at 2.914%. There was very good demand from the indirect bidders at 56% and dealers only took 28%. Directs took 16%. Alas, it popped briefly but before long it was yielding 1.96%. That is not pretty with a bond of that duration.”

Commodities are also a puzzle. Zinc is up on Glencore slashing production, but oil remains the center-piece. We have a rise on oil prices, despite the ongoing supply glut, on fear the Mideast turmoil will cut Syrian production, and nobody is thinking of Iranian supplies coming in. Oil is also up on the idea that US producers must face reality at some point and some will exit the scene. Today’s rig count is sup-posed to point to that. But historically, wildcat oil producers are just that—wild. They don’t give up until something comes crashing down on their heads. While it’s true that Russian military involvement in Syria is almost certainly a game-changer, it’s not clear that expectations of supply cuts are realistic there, either. As for the falling dollar boosting oil prices, bah. The deductive link doesn’t exist. If oil is cheaper on the non-dollar basis, more should be demanded, raising demand for dollars, too. This doesn’t actually happen.

The one good thing about rising oil prices is that they are inflationary, whether the Fed wants to acknowledge it or not. Oil price rises permeate all economy activity and all expectations. If the current rise is sustained and appears sustainable into year-end, December is no longer such an unrealistic date for the Fed to act. It would have to tap-dance around its dismissal of energy prices as temporary and transitory, but never mind. It will have inflation expectations on the rise to justify the hike. Imagine, wishing for oil price rises.

A final factor is the sanity of BoE chief Carney, who told the IMF in Peru yesterday that the market is mispricing yields in the UK to show a hike later in 2016, when he is sticking to a serious probability of year-end. The FT positions Carney’s views as a challenge to market players. For one thing, the Fed is not a “decisive” factor for the BoE. “We will determine the timing for the start of the process of monetary policy normalisation consistent with UK [conditions],” said Carney, according to the FT.

We love it that he uses the word “normalization.” Carney expects “sharper relief around the turn of the year.” The FT notes “UK inflation was at zero, compared with the BoE’s 2 per cent target, and Mr Carney pointed out that most of the cause was cheaper oil and other imports. This effect on the inflation rate, he said, would soon begin to disappear from annual comparisons of prices. With strong jobs growth, and low unemployment at 5.5 per cent, … we are seeing building wage pressures.” Most of all, “Private sector wages are now growing a little over 3 per cent. Underlying cost pressures are recovering, and the natural mechanisms of the economy are working.”

“Natural mechanisms,” hmm. This implies Carney is considering an actual rate hike as a cherry on top of the cake. The cake is overall economic robustness. So then the question becomes just how fragile is the US economy that the Fed thinks it can’t sustain a tiny rise in the cost of doing business? Delaying the hike means, most of all, a negative verdict on the US economy. We appreciate the IMF and others urging the US to go slow, but honestly, the benefits of normalization are being undervalued. Normalization sends a powerful message—it’s okay to invest in hard assets (capital spending).

Besides, the incoherent House Speaker-in-waiting withdrew, giving the current Speaker the chance to clean out the barn, and that means we could get funding/debt ceiling approval, if not a full budget. To the extent a prospective government shut-down was worrying the Fed, that factor may be diminished now.

Normalization is looking like a remote possibility at this point and that’s a profound dollar negative. We expect to see the dollar far weaker before long.

Note to Readers: Monday is holiday in the US to celebrate the discovery of America by Christopher Columbus, an Italian hired by the Spanish queen who was half-Portuguese. Now consider why we all speak English. Europeans tend to dislike American claims to “exceptionalism,” but historically, the US really is exceptional—it was invented from scratch, with no tribal/cultural baggage. The British in particular sneer at the US when we speak of something (like buildings) as “old” that are hundreds of years younger than their “old” stuff, but that’s precisely the point—the US is still “new.” Because the US is exceptional and new doesn’t make it better or worse but those attributes surely make it more interesting. Anyway, no reports Monday. We will publish the spot afternoon report because it’s more convenient than trying to catch-up.