The Fed’s Final Bullet

by David Haggith 

Fed missteps and flip-flops this week tripped up multiple markets. After accidentally announcing their ammo is down to one last bullet against recession, can they be trusted to handle powerful weapons?

Given how the market is now trading on nothing but the Fed, it’s no surprise that it leaped up instantly in the middle of weak when the European Central Bank announced it may be raising its long-time inflation target from “just below 2%” up to 3% just as New York Fed President John Williams (a voting FOMC member) said the Fed should respond quickly to recessionary troubles with its own rate cuts.

Obviously, investors couldn’t care less about drilling into why the Fed should need to respond so quickly any deeper than Williams statement that it should do this because the Fed has limited resources left with which to do anything! The market wouldn’t have shot up if it had any depth of thought.

One might think that admission by the Fed would actually be concerning. One might think it would actually be alarming after Williams next words in which he estimated the new neutral rate for Fed funds would be somewhere around 0.5%, instead of the 2.25%-2.5% the Fed has currently targeted. In other words, setting interest one notch above zero in this reserve bank president’s view, will no longer have any stimulative effect. So, the Fed needs to drop to the zero bound immediately in order to fend off recessionary forces.

Any drop to a rate higher than zero will provide no economic boost.

That means the Fed has only one bullet to fire.

Williams sees a 0.5% Fed funds target as the new normal necessary just to maintain the economy where it is. He further indicated this situations is bound to linger a long time. Yet, rather than being alarmed by this massive revelation from one of the primary Fed movers and shakers, investors reacted as if saying, “Then recession be damned; free money forever is coming!” Stocks temporarily jolted upward as if nothing could be better news!

Williams’ comments certainly underscore my message about the Fed’s next more-extreme course of action in the video interview I posted earlier this week: “The Recession is Now.”

But, then, before the end of the day, the Fed scrambled to walk all of this back by saying Williams “was only talking academically” and not speaking about actual Fed policy. Uh huh. Sure. First, the New York Fed’s official press spokesperson contradicted the New York Fed’s president because market’s got so excited over William’s statement that they immediately priced in an additional Fed rate cut, essentially demanding the Fed do what Williams just proclaimed, intensifying the Fed’s pressure to perform.

Then another reserve bank president leaped in to say Williams didn’t really mean it. What? The Fed almost out of ammunition for fighting recessions? No, he didn’t mean that.

The Fed looked a bit like a three-ring circus of competing market jawboners. Plate spinners in each ring were running to the other rings to help keep the other guy’s plates in the air.

Don’t worry about this debacle, though. These are just the people in charge of global money supply. To me, it looked like Williams let slip the truth that the Fed has only one bullet left with a recession squarely in site, and the others jumped in to bury his slip. Many in the media commented on the peculiarity of the moment. For example, Bloomberg’s Cameron Crise summed up the fiasco this way:

For NY Fed president Williams to talk about the need to ease early and hard in the event of a downturn — and with the Fed about to embark on an easing campaign in less than two weeks — was about as clear as policy signals get. It’s no wonder that the market- implied probability of a 50 basis-point cut this month jumped by 30% after the comments hit the tape. For the institution to then turn around and wave away the remarks as an academic exercise was as astonishing as it was inappropriate.

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People flounder about like that when they feel desperate, but this Fed flip-flopping puts its credibility at risk. When you have only one bullet, you can’t afford a misfire. The world could lose confidence in whether or not Fed officials know what they are doing with their bullet — a bit like Barney Fife. You don’t dare risk losing confidence in a confidence game.

Maybe the Fed is down to one bullet because that is all we dare trust them with. Oh, well, it will only matter if they actually need to use it.

On all other banking fronts around the world, JPMorgan said this week that it expects twelve central banks to move into full monetary easing mode within the next two months. Does that sound recessionary? Gee, and that just takes us to the end of summer, still within the time frame I gave for a summer recession, and central banks are not known typically for changing back to easing until after a recession begins. They are also not known for ever telling you one has begun until it is half over and too completely obvious to deny.

Looks like Barney is going to need his bullet, and with the kind money-effacing recession we have coming, he’d better hope it’s a silver one.

 

 

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