Fed: The statement is all too likely to disappoint

Outlook:

Traders are paring short dollar positions ahead of the Fed statement at 2:30 pm. This is a "just in case" precaution against anything that might look even remotely hawkish. It's silly to expect a surprise, especially in the absence of a Yellen press conference. Analysts will have to pore over every word for clues about how the Fed now sees inflation (and thus the next hike) and the upcoming gradual drop in purchases. The statement is all too likely to disappoint. The Fed expects inflation to stabilize but we don't know how much of a rise over how many months we have to see before the Fed is comfortable with that third rate hike. It doesn't seem to be pending right now, hence the consensus view of no hike in September but maybe in December.

Talk of not getting anything definitive today from the Fed statement is mitigated by expectations that Yellen will say something important at Jackson Hole in late August. This is a pipe-dream. Yellen can be bold and was the most straight-forward of the regional Feds when she was at the San Francisco Fed, but she is also deeply conventional and whatever the equivalent term may be in economic leadership for "prudish" in dealing with the public. She is not likely to let any cats out of the bag outside the regular scheme of things.

Yellen may, however, revert to a theme long lurking among the economic analysis shrubbery—the "natural" (or neutral) rate, which is the proper rate of interest that neither promotes nor impedes growth or inflation. We also have a "natural" rate of unemployment vs. inflation and natural/neutral rates of various other factors. Underlying all the theories is that some variables have to be assumed to figure out the result of the formula. In the case of interest rates, you need to guess the right rate of inflation in the context of growth. The guess of 2%, adopted by many central banks, is just that—a guess. A target inflation rate of 2% is reasonable when growth is assumed to be 3.5%, for example. But as we know, the current US GDP forecast is more like 2-2.5% at best.

The "natural/neutral" rate of interest is badly correlated with actual historical growth and inflation data. On the whole, inflation has typically surprised central banks and the institutional response has come at a long lag. Remember Mr. Volcker. And this is precisely what all Fed govs fear, including Yellen. It seems like the inflation trajectory is tame. But what if something comes along to spike inflation? The Fed would be caught flat-footed with its rate barely over 1%.

Tradingeconomics.com summarizes: "Core inflation rate in the United States which excludes prices of food and energy remained at a two-year low of 1.7 percent in June of 2017, the same as in May and in line with market expectations.... On a monthly basis, core consumer prices edged up 0.1 percent, the same as in May and below forecasts of 0.2 percent. Core Inflation Rate in the United States averaged 3.67 percent from 1957 until 2017, reaching an all time high of 13.60 percent in June of 1980 and a record low of 0 percent in May of 1957.

The chart says it best. To the extent that rate hikes are predicated on actual and expected core inflation, we should not be expecting another hike. Yellen has never said or even suggested that hikes are justified on the grounds of normalization alone or in the absence of rising inflation and inflation expectations. We imagine the idea is alive and kicking in her head, but if so, she has never expressed it, nor have any of the Feds. Hence terms like the "new normal," which are really an expression of the inadequacy of all the "natural/neutral" rate constructions.

Then there's politics. Yesterday Trump gave a long interview to the WSJ without an agenda or a list of talking points, and bounced around all over the place, mixing up comments about the US economy with trade and foreign affairs. Reporters have a hard time making him stick to a single subject for more than a sentence or two before something else leaps into his head. He repeated that NAFTA re-negotiations are underway alongside a pullback from the steel dumping issue, claiming he is waiting for more information. Since when does he need facts?

The most important tidbit and the one that got the headline was a commitment to reform the tax code, saying the middle class deserves a break. Quite how is unclear. Trump is okay with not giving the richest the usual Republican tax break and claims to be sticking to the 15% corporate rate, despite Republican congressmen having already said 15% can't be done and the number in the end will be higher. Since Trump outsources everything that entails real work, it will be up to Congress, anyway. Anyone seeing a glimmer of stimulus from this interview is engaging in wishful thinking. Tax reform is as hard or harder than healthcare reform.

And the Russia thing drags on an on. The latest talk over the past few days is Trump hinting he wants Attorney General Sessions to resign because he had to recuse himself from the Russia investigations because he got caught being involved with Russia, after all. Trump wants loyalty to him rather than to the law. The thinking is that Trump will eventually fire Session so that he can appoint a new AG that will close down the independent special counsel investigation—a Nixonian Saturday night massacre. Analysts point out two interesting deductions: what ignoble person would take the job? His reputation would be forever ruined for becoming Trump's poodle (a slander against poodles). Remember Bork, who was the Nixon hatchet man and later lost a Supreme Court seat for it.

More importantly, if Trump's chief goal is to close down the Mueller investigation, what does he fear Mueller will find? He must be hiding something he doesn't want disclosed. It may not have anything to do with Russia, either. For all we know, Mueller already has all of Trump's financial statements, including tax returns. Mueller is allowed to disclose data from that private information if and only if disclosure is directly relevant to his investigation.... But crimes discovered while investigation one thing can be included in the investigator's case, expanding it. Mueller may get Trump on something like tax evasion rather than anything to do with Russia. Presumably this is what Trump wants to hide.

Realistically, it was always going to be some kind of financial fraud or misdeed that brings Trump down. His business history is rife with cheating, breaking contracts, defrauding, lying, and sometimes just plain theft. The man can't manage his way out of a paper bag. A poll shown far and wide yesterday has 42% of respondents wanting to impeach. Alas, an equal percentage do not seek impeachment. Watch those numbers. Weirdly, the dollar will go up if Trump is impeached.