June: The Trifecta For Policy Error?


In about 30 days, the Federal Reserve will hold its scheduled June (13-14) meeting of the FOMC to either give a thumbs up or thumbs down to increasing interest rates in earnest once again. The odds that the Fed will indeed raise again now stand at about 99%. In other words – it’s all but a near certainty.

With that said, one can’t help but marvel at not only the markets’ sheer abandonment on volatility with such a near certainty on its doorstep. But rather, the only thing to rival it is the sheer arrogance being displayed by the Fed itself that such another increase is warranted, as all data pointing to a self-professed “data-dependent” consortium is not just flashing, but screaming danger with every passing day. E.g., B.E.A. Q1 GDP 0.7%, Atlanta Fed. GDP Now™ 0.2%, JPM Cuts Q1 GDP to Just 0.3%, and more.

In days of yore (i.e., ancient history circa 2016), whenever the odds of hiking approached anything like the levels it does now, the Fed would take to the media in any manner possible and try to supplant soothing tones of, “Hush now little ones, and not to worry…” as to make it evidently clear it had no such intentions going into its next meeting. After all, as history has shown time and time again, just the “idea” that a rate hike could be imminent sent the markets reeling needing for an ever-incessant response of one Fed official after another to shout, “Don’t worry! We’re here with ever more potent QE should the need arise!” This is why we now have such a thing being worthy of its own moniker, i.e., “Bullard Bottom.”

Today, the exact opposite is the case. Not only are there not any soothing tones, but rather, there are tones emanating from what can only be described as an outwardly defiant, all-seeing, ever-proficient collection of “Hawks Are U.S.” for any and all questioning.

As an example, in what can only be taken at first glance as a “Wait, what?” moment, the New York Fed has concluded that the more than $500 trillion (and rising – again!) of OTC derivatives outstanding remain (wait for it…) “an important asset class.”

For those of you having that “Wait… what?” moment as you’re reading this and just can’t remember why your brain just froze from the absurdity of such a statement, that’s because “derivatives” was that phrase you recalled as the center for every reason which caused the great financial crash. (For those of you wanting more on this topic, I highly recommend this succinct breakdown by Wolf Richter of Wolf Street.)

So why is the above important other than its “ticking time bomb” factor? (As if that weren’t enough.) No, the reason why it stands out for me is how it’s viewed by members of the Fed itself, i.e., “Don’t worry, we got this!” And here’s the reasoning.

If it’s now on the books (see above) openly stating its acknowledgment with its size and scope, along with, the fact that the Fed itself sees it as an “important asset class,” that makes the case (or allows for it) that the Fed itself not only allowed, but rather with eyes wide open helped facilitate its further ballooning. Hence, if (or when) it “pops,” the Fed has no one else to blame but itself (along with the potential hordes carrying “torches and pitchforks”), for the Fed has now openly stated (again, and inserted it into its report) it not only knew of this, but rather considered it as an “asset class” – i.e., giving this its blessing and endorsement.

Remember how the other all -important “derivative” class of asset-backed securities worked to facilitate the “Great Financial Crash?” Hint: CDO, MBS, CDS, just to name a few. That too was another “We got this asset category.” Feel better?

The real issue that sits squarely in front of the “markets” is the realization that the entire “reflation” trade may, in fact, be D.O.A. – much like the legislation that was supposed to foster its existence to begin with. Let me put it this way since we’re talking about “derivatives” and their potential for highly correlated monetary wealth destruction vehicles.

The “reflation” trade that is now omnipresent in the “markets” which has facilitated the non-stop rocketship ride since the election of Donald Trump is nothing more than a “derivative” vehicle (or expression) of the underlying legislation that was to be its foundation or “backing asset,” i.e., signed into law.

In other words, if the legislation (i.e., tax cuts, Obamacare repeal, etc.) doesn’t become signed into law amounting to precisely what the “value” of those cuts and more represented (i.e., $1 trillion in infrastructure, Obamacare total repeal equivalents, massive corporate tax restructuring etc.), the entire run-up from November 2016 to today becomes de facto null and void. The “derivatives” (as in the profits made) based on “the trade” become …? Hint: It’s not good.

The only thing that could (or will) make matters worse was if the Fed had raised interest rates in anticipation. Again, hint: Not only has the Fed raised rates, it’s raised twice and is looking to raise a third time, all into further deteriorating economic data.

To re-emphasize just how precarious the “market” now sits, below is a chart that I feel puts it into perspective. To wit:


As one can see, that red rectangle represents the turmoil the “markets” had portrayed once the QE “IV tube” for all monetary woes was removed. Again, not only did the market suddenly halt its ever-ascending journey, but it suddenly produced ever-increasing bouts of near-death experiences, needing ever more dovish tones from the revolving cast of Fed speakers hitting the media in ways that would make a Kardashian envious.

Again – for I can’t mention this enough – right before the election in October 2016, the economy was on such shaky footing (and as the markets were rolling over once again), the Chair of the Federal Reserve gave what I call her most contradictory speech when juxtaposed against today’s raising into weakness, stating (paraphrasing here): Running a “high pressure” monetary policy may be the only way to heal the damage still residing within the economy via the crisis. An “ultra-dovish” insinuation, if ever there was one.

And yet, as the above shows, just 30 days later, with the victory results of Donald Trump now into the books, the Fed morphed into “Hawks Are U.S.” and has been ever since.

I made note of this and was subsequently mocked via the mainstream business/financial media as something that “ain’t gonna happen” using the prior 2 years as evidence. Directly after the meeting, most analysis was, “They’ll probably not raise again till mid-year, if then.” Then, all the jawboning for more began in earnest via one Fed official after another, including “balance sheet reduction.” Then March happened, and now June is about to. Here’s what I wrote in December of that week. To wit:

“I implore you not to solely take my word, but to watch the presser for yourself and draw your own conclusions. I believe it’s one of the most forceful expressions made, or conveyed by The Federal Reserve that it may in fact act aggressively via monetary policy should it decide – It (“It” being the Fed.) seems fit. i.e., The implications seemingly being sent are that they’ll decide what a “good” economy is – fiscal implications be damned.

Now is where “fiscal implications be damned” might be far more relevant than the Fed (as well as the markets) ever imagined. The reasoning? All that “fiscal” seems to now be damned to not seeing the light of day as far as 2017 may be concerned. And that’s something I feel the Fed hadn’t calculated into its conclusions (never mind the markets). After all, with both the House and Senate topped with a president all controlled by the same political party, how would legislation not be passed swiftly? (Although many others wonder that exact same thing, but I digress.)

However, with that said, the economy was/is in no shape (just using the “data” we’re all told influences a supposed “data-dependent” Fed) for incessant hawkish jawboning followed by raising rates twice within 90 days. Again, all while arguing (and allowing the inclinations to be held via the futures fund) that the Fed is indeed “hell bent” on raising once again, in June!

That would be 3 raises in all but 6 months, with balance sheet reduction arguments still front and center in Fed communications when speaking in open forums. Are you beginning to see the implications for “policy error” more clearly?

I’m sorry to keep repeating, but it’s something which cannot be repeated or stressed enough with further deteriorating GDP and other metrics, along with no fiscal stimulus possibly seeing the light of day (meaning actually signed into law) for the rest of 2017, along with a potential government shutdown and more. June is now to be considered (due to the Fed not saying or refuting anything to the contrary) a done deal. And a prudent one at that.

Oh, and for those who may want even further examples for contemplation, here’s just one of the items that can be classified under “and more.” Hint: China.

But not to worry, for if you listen to current Fed officials and their assessment of global economic conditions, you know where the “reflation” trade is the “derivative” of the underlying asset of passed legislation (which has gone from “passed” to all but the DOA) that the entire recent run-up is based on.

The Fed has “got this!” Just like it’s got those other “derivatives” under its watchful eye. So June is now a shoe-in.

Feel better?