Bringing a bazooka to a gun fight

In the end it was a dovish pass, and so Yellen rolled up to the Rate Hike Corral carrying a bazooka to a gun fight, laying waste to those cowboys brave enough to be short the front end of the curve.  There's a lot that one could say about yesterday, so let's start by ticking off the checklist from yesterday's post:

* The rate decision:  As expected, unched.


* The wording around the decision:  On balance, quite dovish.  They inserted the line about global unruliness, but threw only the skimpiest bone to the solid domestic activity situation.   Most importantly, the policy/guidance section of the statement was completely unchanged, thus offering no prospect that their fingers are on the trigger, waiting for the market to settle down.

* Growth and inflation forecasts.  Despite the increase in its 2015 growth forecast, the committee managed to nudge down its 2016-17 forecasts while simultaneously reducing its unemployment rate forecasts.  Naturally, inflation forecasts were chopped across the board.   This was more dovish than Macro Man expected.

* 2015/16 dot plots.  As expected, these were marked down, with the central tendency marked down by 30 bps per year.   Although the market characterized it as dovish that one member pushed back their rate hike vote to 2016 (edit: and another to 2017), frankly given every thing else Macro Man thought that was pretty neutral.  Bizarrely, one member decided that after six years of this nonsense, now it is finally appropriate to push ahead with negative rates.  One can only presume that this was Kocherlakota, who finally pissed away what few remaining shreds of credibility that he retained after summarily firing his economics staff for having the temerity to disagree with him.

* Longer run dot plot.  A bit lower, as expected.   What's interesting is that there are fewer topside outliers than there were a few quarters ago; this reflects both the composition of the voters (Plosser was clearly one of the outliers), and an admission even amongst the hawks that rates will be low by historical standards for a long time to come.

* The press conference.   To her credit, Yellen gave short shrift to the negative rate thing and tried to carefully characterize the liftoff as the removal of an emergency policy setting rather than an attempt to tighten conditions to restrain the economy.   This is a point that will need to be stressed if they are to get on with it.   As for the rest....jeez.   Long (and to Macro Man's ear, repetitive) lectures on inflation and its outlook suggest that she and the Fed are still believers in the Phillips curve, that 2% is an appropriate target, the Easter Bunny, and that O. J. didn't do it.

Here's a fun fact for you:  Over the last 20 years, the core PCE deflator has been at or above the 2% threshold just under 25% of the time.  If we remove the GFC from the equation and just look at the decade from 1998-2007, we find that the core PCE deflator was at or above 2% just over 33% of the time.  The 20 year average of the core PCE deflator is 1.70%, which might suggest that the FOMC's stated 2% target represents more than a little wishful thinking.

Moreover, see if you can spot the trend in industrial capacity utilization over the past 30 years; might this have something to do with the secular downtrend in inflation?

Yellen also trotted out the usual boilerplate fluff about needing to see more improvement in the labor market.  The current unemployment rate is already below the 20 year average (6.0%), and indeed is in the lowest 1/3 of all readings since the data begins in 1948.  To be sure, the current rate masks some hidden fragilities in the labor market (such as the ongoing inability of friendly punter/bloggers to find a gig), but still.   Yesterday's unadjusted jobless claims were the lowest since 1973, fer cryingoutloud!

Sadly, we need to acknowledge that calling the FOMC has absolutely nothing to do with economics (cue a round of 'I told you so' from the peanut gallery.)  For someone to be calling for negative rates with the economy and financial markets in their current state is frankly an embarrassment to the institution, as is their apparently never-ending search for an excuse to stand pat.

Janet Yellen tried to re-iterate several times yesterday that the vast majority of the committee expects to raise rates by the end of the year.   The market just laughed at them, with January Fed funds ripping to a new closing high.

Not ripping, of course, was the S&P 500, which tried to rally but then faded sadly, closing down on the day.  It's tempting to view this as a vote of no-confidence in the Fed's credibility, though more prosaically it's probably got quite a bit to do with a triple-witching expiry today as the index hovers around a key psychological level with plenty of open interest.

The next few weeks will tell the tale of how the market really views the Fed.  If Macro Man's views on the impact of Fed uncertainty are correct, then risky assets should struggle.   It really is a patent absurdity for the head of the Federal Reserve to declare that every meeting is "live", but that they need to gather more data to be confident about the labor and especially inflation outlook.

Seriously, what kind of data could realistically be released in the next month that would change their minds on inflation?   It seems difficult to fathom.  Listening to to Yellen speak about the data on Thursday, it sounded like they were a long way away from being comfortable on inflation, however misguided their target may be.  And yet a large proportion of the committee still expect to raise rates this year.   That, in a nutshell, is why the Fed's credibility is at a very low ebb indeed.  What that means for asset markets depends on your belief in the Fed's apparent omnipotence.

From Macro Man's perch, policy error normally gets punished in one form or another, sooner or later.  The conundrum this time around is that the punishment (lower risky asset prices) will only perpetuate the error.