December FOMC Meeting to Provide Clarity on 2015 Rate Hikes by EconMatters
4 Trading Days – Important Fed Meeting
The FOMC Meeting Announcement, Forecasts & Chair Press Conference on December 17th should provide more clarity on the rate hike schedule for 2015 as this is the first quarterly FOMC meeting since QE Bond Buying has formally ended. Given that third quarter GDP was revised up to 3.9%, and the Employment numbers this year have been record setting by historical standards (More jobs created on an annual basis in 20 plus years) and there is far too much liquidity in the financial markets as witnessed by both bond and stock prices at essentially record highs at the same time, it is time to start raising interest rates, and fast.
Oil Prices Only Inflation Component Down – Watch Transfer from Energy Component to Core Inflation Getting Hotter Inflation Readings as witnessed by last month`s PPI & CPI Reports.
We are already seeing all inflation metrics rise except one in energy (due to an oversupply issue because of US based Shale Production) Core Inflation is definitely rising, and we are starting to see the Energy readings move down because of the drop in energy prices, but move into the core reading inflation metrics, which is what we would expect to see given an above trend growth environment. Lower gasoline prices are actually inflationary and pro-growth stimulative for the overall economy. As consumers have more money in their pockets due to lower gasoline prices they spend more on other discretionary spending items like Movies, Retail Shopping, and Dining Out.
Lower Oil & Gasoline Prices are Inflationary Stimulus in the Overall Economy
This increases demand pressures in the system and merchants raise prices now that they have more pricing power, and then need to hire more workers because business has picked up due to more money coming in as consumers have a massive tax cut from lower fuel costs and spend more in Restaurants, Shopping Malls, and Entertainment categories. The latest PPI and CPI readings were actually quite robust once you take out the energy component, and as you notice the Airlines are raising prices not lowering them even though they are all getting a huge benefit from lower fuel input costs. So areas where consumers might expect inflation to drop because of lower fuel costs just isn`t going to happen in an above trend growth environment. This is why lower fuel costs and a huge tax break in the form of more discretionary income for consumers is actually inflationary in an above trend growth environment because increasing demand pressures with 200k per month job additions with incomes and more available discretionary income for all consumers means more money chasing the same core components in the core bucket, thereby raising prices and causing inflation to rise in the core readings.
GDP Reporting Above Trend Growth
With the second quarter GDP number of 4.6% followed by what I think when all is said and done is another 4% plus GDP quarter for the third quarter, and another 3% plus 4th quarter after all revisions are in, the core inflation numbers are going to start spiking – it is simple economic theory or pricing and demand pressures playing out in the economy. Throw in the 200k plus monthly employment pressures with a tightening labor market and wages are already rising ahead of the official inflation readings for 2014, and I expect both the Core Inflation Readings and Wages to rise more than most economists expect in 2015 as the above trend growth continues in the first half of 2015.
March 2015 Rate Hikes
I think it will become apparent to Wall Street and the Federal Reserve that they are going to have to move up the June time frame for rate hikes, an event that is currently not being priced into the financial markets at all. There is just way too much liquidity in the financial system, most financial markets are completely broken due to the overflow of liquidity in the system, and the entire market is setting up for a massive liquidity trap if stimulus is not slowly withdrawn, i.e., “starting the unwind process” ASAP, in the form of Janet Yellen setting out a much more Hawkish tone regarding Rates in this upcoming quarterly Press Conference to signal to financial markets to start getting out of highly-levered liquidity driven positions like Yield Chasing at any Price level.
Central Bankers Enablers for Bubble Creation in Bond Markets – European Bonds Absolutely Worthless at these Prices
Central Bankers really are being taken advantage of by market players, this is being played out in Europe where Mario Draghi is being pressured to take on all these QE initiatives that really only serve one purpose to give free liquidity to financial markets so that players can have more cheap money to borrow to push asset prices up to more unsustainable levels. The game works this way complain, whine, put pressure on the Central Bankers, get lower borrowing costs, borrow and invest in electronic markets. It is not the fact that European rates are too high which is holding Europe back from growing. The irony is that Draghi is part of the problem by reducing European borrowing costs this just further incentivizes more inappropriate uses of capital allocation by European Banks instead of loaning to small businesses which would have add on effects of increased employment in Europe – they just take the cheap liquidity push a couple of buttons and buy more European Bonds pushing prices up further, and none of this stimulus ever goes outside the financial system. This is one of the more growth stifling nasty effects of ‘abnormally low rates’ it incentivizes inefficient and unproductive uses of capital allocation by financial institutions.
Debt to GDP Ratios, Historical Bond Prices, Risk Reward Models & Responsible Investing?
Instead of vetting and seeking out business project investments in Europe, European banks just borrow at 10 basis points and buy bonds (in some cases at negative real rates) with little regard for risk and valuations because the ECB will come to the rescue and buy all these bonds in the QE Program that they pressured Draghi to entertain, and this not only doesn`t spur economic growth in Europe, it actually means the ECB will need to be bailed out.
There is no way if you look at the spiraling Debt-to GDP Ratios across Europe that any of these European Bonds at current prices will not be underwater by 50-60% in 5-10 years’ time. The worst mistake for Europe was lowering the borrowing costs, they should have been raising borrowing costs to more normalized conditions, and they further aggravated this mistake by promising a QE program to buy all these ‘over-valued bonds’ from the European banks – this means much of the capital normally allocated to small business and startups went to ‘Electronic- Paper Based’ trades that never find their way out of the financial markets, all the while hurting the European`s purchasing power by debasing their currency.
Given the history of European Debt-to GDP Spending patterns, and a solvency crisis just 2 years ago, this is going to prove the most massive mispricing of any mainstream asset class in the