Three Critical Dates for the Fed
I managed a track and field in team in high school. I was not the team coach, I was a student-manager who helped out with equipment, scheduling, training and other logistics.
Back in the days before internet I was the kid in the locker room phoning in athlete times and results to the local newspapers before the deadline for the next day’s edition.
I loved the faster track events like the 440-yard sprint and the half-mile distances. I always thought the most challenging track event was the high-hurdles. This combined speed and endurance, with precision coordination and athleticism on the jumps. One mistake in mid-air could result in a disastrous crash on a cinder track and a bloody injury.
It’s hard to picture Janet Yellen in a track suit, but she’s about to run a high-hurdle race of her own. She needs to clear three hurdles perfectly to make it to her self-imposed rate hike finish line on December 13. One false move and her plan to hike rates could end up in a bloody mess on a cinder track.
As you know, the Fed is on track (no pun intended) to hike rates at their FOMC meeting on December 13. This is as close to a “done deal” as you can get. Markets give this rate hike a 100% probability based on the implied probability from the CME fed funds futures contracts.
I’m the outlier.
I’m alone on an island saying that the Fed won’t hike rates based on nine straight months of bad inflation data. I’m not trying to be “in consensus” or “out-of-consensus,” I’m just trying to follow a Fed model that has been almost flawless in its predictive power since 2013.
That model has hit a lot of home runs. If I strike out this time, I’m not going to abandon the model. Even Babe Ruth, Henry Aaron and Willie Mays had their share of strikeouts even as they had slugging percentages in the .700+ range. Fine by me if we can keep up those kinds of long-term results.
Yet, even if you don’t use my Fed model or don’t like to be out-of-consensus, you still have to acknowledge the hurdles facing Janet Yellen as she races down the track to December 13. Here they are:
Tomorow, November 30: This is when the Commerce Department releases the “PCE deflation, core year-over-year” number. Sounds geeky, but that’s the specific inflation number the Fed uses as a benchmark.
The Fed’s target is 2%. The last reading was 1.3%, down from 1.9% at the beginning of 2017. If this number comes in at 1.3% or less, it’s hard to see how the Fed raises rates unless they are willing to ignore their own benchmark in favor of the mythical Phillips Curve and even more mythical “stimulus” effects of the proposed Trump tax bill.
Important voices like Neel Kashkari, Charles Evans, Lael Brainard, Benn Steil and others are already warning that a rate hike in December could be a huge blunder if the inflation data is weak.
We’ll see how this plays out. For now I’m betting on more weak data and that the Fed blinks at the last minute by not raising rates.
Friday, December 1: This is when the Senate votes on the Trump tax bill. The actual macroeconomic effects of this bill are irrelevant for the moment. What matters is the importance of a “win” for the Republican Party and the stock market.
Right now the Republicans do not have the 50 votes they need. Can they get them by Friday? That’s uncertain, but there’s a good chance they won’t succeed.
In that case, you’ll have a replay of the failure the of Obamacare “Repeal and Replace” drama. Markets will sell off big time if the tax bill fails. That kind of sell off, plus the failure of the presumed stimulus will be enough to get the Fed to pause in their rate hike path on December.
Friday, December 8: This is when the government spending authority shuts down and the Treasury hits the debt ceiling. A “Daily Double” for government dysfunction!
The debt ceiling won’t immediately impact the Treasury market because the Treasury can use “extraordinary measures” (including a gold price reset) to keep paying the bills until early next year. Then a hard debt ceiling will be hit. Still, any market uncertainty is one more reason not to raise rates.
Of greater immediate impact is a government shutdown. Of course, shutdowns have happened in the past, and have always been temporary, never the end of the world. Some last minute fix is possible. Even if the shutdown occurs, it’s likely to be over in a week or so.
But, there are only three business days between the scheduled shutdown and the FOMC meeting. It’s hard to imagine the Fed tightening financial conditions when the entire government (or at least “non-essential personnel”) are locked out of their offices.
The issues that could cause a shutdown are all difficult to compromise including Trump’s “Wall,” Obamacare funding bailouts, Planned Parenthood funding, immigration, disaster relief, flood insurance bailouts, and many more.
Here’s the bottom line:
If PCE is hot (1.6% or higher), the tax bill passes, and the government does not shut down, then Yellen has cleared all three hurdles, and she’s on her way to a rate hike finish line.
If she stumbles on any one of these hurdles, let alone all three, then a rate hike is off the table. If the odds of failure are each hurdle are 33% (about right in my view), then the odds of failure on one out of three are 99%.
No one in the market is thinking about the odds that way, but a statistician will tell you that’s the right way to analyze it.
Since markets are 100% priced for a rate hike, nothing much happens if the FOMC actually hikes rates. But if the rate hike does not happen, markets need to reprice for the new reality. That means gold, euros, yen, and Treasury bonds will soar, and the dollar, bond yields, and stocks could crumble.
These are asymmetric “heads you win, tails you don’t lose” trades. You could have big gains if the Fed pauses, but won’t lose much if they don’t.
These hurdles are coming up in days, so the time to enter these trades is now. The easiest way is to buy gold or gold mining stocks.
Then sit back and enjoy the show.
Regards,
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