Fed Folly Continues – Hoisted With Their Own Petard

 “Well, I never heard it before, but it sounds uncommon nonsense.”

- Alice in Wonderland

“Everything is not what it seems,
When you can get all you wanted in your wildest dreams,
You might run into trouble if you go to extremes,
Because everything is not what it seems”

- Everything’s Not What it Seems, by Selena

“And you may ask yourself, well…how did I get here?

- Once in a Lifetime, by the Talking Heads

“The future ain’t what it used to be”

- Yogi Berra

• We have now suffered through another ridiculous cycle where market participants have attempted to apply logic and analysis to what the Federal Reserve may or may not do and how they may or may not describe what they may or may not have done.   Ridiculous.   And now, one week later, the Fed takes to the bully pulpit again to proclaim, in different words, what they may or may not do, depending on conditions no one can fully understand or forecast.   Uncommon nonsense.
• The Fed has certainly painted itself into corner.   It has declared its decision making process to be “data dependent”.   Yet, it is clear that the “data” that they use as inputs have been heavily coerced for years — the government has been massaging how unemployment, inflation and GDP are calculated to make them appear as positive as possible.  The degree to which this has been done is constantly tracked by John Williams at www.shadowstats.com:
  • The Official U3 unemployment rate is around 5% — the broader U6 is in the 10% range and the Shadow Stats estimate is in the 23% range.    Shadow Stats simply adds back long-term discouraged workers that were taken out of the statistics back in 1994.
  • The Official CPI-U inflation rate is near zero — the Shadow Stats estimate using the government’s own methodology from 1980 is in the 8% range, and, using the government’s own methodology from 1990 is in the 3.9% range.
  • The Official BEA GDP annual growth rate is in the 3% range — the Shadow Stats estimate is in the -1% range and has not been positive since 2004.
• So the Fed must now knowingly engage in double-speak, having to explain why the “data” says one thing, but they must draw different inconsistent conclusions.   They know actual inflation is more in line with what Williams suggests, but if they admitted that they would have to begin raising interest rates aggressively to avoid an inflationary spiral.    On the other hand, they know actual unemployment is dramatically worse that what the “data” suggests, so even though the “data” says that they have reached their “full employment target” objectives, they really don’t want to tighten given the state of short and long term discouraged workers.   And, finally, they know that economic growth (GDP) is worse than the “muddle through” growth that the “data” suggests and that we may actually still be in recession, so, again, they really don’t want to tighten.    They live now in a world of rhetorical opposites – they cite inflation as a reason not to tighten, but it is actually why they should tighten.   They cite unemployment and GDP as reasons to tighten, but they are actually why they shouldn’t tighten.    Everything’s not what it seems.
• The Fed’s asset targeting philosophy has now done to the stock market what they did to the housing market in the last cycle.   As noted in the most recent post in The State, the cumulative growth of the S&P 500 is now 3x the cumulative growth in earnings;  S&P 500 operating earnings peaked in 3Q14.    The last two times earnings peaked like this was in 2Q00 and 2Q07.   This may turn out to be a false signal, but this is an important observation.  You can be sure that the Fed will do anything in its power to try to hold the stock market up after their experience with the bursting of the housing bubble.
•  The other unintended consequence that continues to confound the Fed is the currency effects of policy decisions.   Given global central banking monetary programs, any Fed tightening puts immediate upward pressure on the US Dollar Index. It is hard to imagine a situation in the near term where the Fed will feel free to tighten and not worry about currency effects.
• Given the lackluster reaction in the equity markets to the Fed speak over the past week, perhaps we have collectively reached peak exhaustion with this ridiculous cycle that the Fed has perpetrated.   What if the markets begin to have a negative reaction to the Fed’s inability to act and its constant gumming at the bully pulpit?   What if the collective perception becomes that raising rates, like taking your medicine, is the best of a lousy set of choices?  And you may ask yourself, well…how did I get here?
• The Fed seems to have been hoisted by their own petard.  They probably thought (naively) that they could run these extraordinary programs until the economy got going, and then exit into positive economic situation.   Further, they probably thought they could run these programs in an isolated and domestic way, without any currency and/or economic repercussions in the global economy.   Now, neither are true.   They probably cannot exit the programs without negatively affecting the economy and currency markets, and the economy will probably not improve until they stop meddling in the markets and allow them to normalize.    Hoisted indeed.   No wonder Yellen felt faint at her last press conference.   The future ain’t what it used to be.
• One more Yogi Berra quote seems in order and in honor of his life.   “We made too many wrong mistakes”