FOMC Statement Makes A Statement Without Really Knowing It
Oh, the irony. Recall Janet Yellen’s plight, circa early 2015. Oil prices were “unexpectedly” crashing raining on her recovery-like parade. The Federal Reserve, Yellen as its Chairman, was about to embark on an ambitious program of regular every-meeting rate hikes to head off, its models assumed, the coming inflationary bump which was to confirm full if belated monetary policy success.
What they didn’t quite know was exactly when this would begin.
But in the second half of 2014, the global crude market rudely interrupted all the carefully calculated plans. Worldwide, oil prices tanked in what was wrongly characterized as a “supply glut” simply because Economists and central bankers (same thing) can never fathom monetary policies being so utterly inept and ineffective.
It was the anticipated hand-off; QE3 and 4 begun back in 2012 was supposed to be retired by the end of 2014 (it was) as it achieved its goal, its real goal which was unambiguous economic liftoff (not some ambiguous nonsense about term premiums in Treasury yields) rising inflation rates merely confirm. What should have followed would have been near immediate rate hikes (recall one of Janet Yellen’s first “mistakes” as Chairman when she took over from Ben Bernanke earlier in 2014 was to say that she figured rate hikes would start about 6 months after the end of QE).
The FOMC always assumes that, due to decades of their own good work (forget that whole 2008 thing-y), inflation expectations are and remain firmly anchored at their 2% inflation target. Deviations, therefore, would only ever be temporary, transitory, and transient. Unless, of course, inflation expectations aren’t actually anchored (then you’d have to ask the monetarily uncomfortably question of just what could cause such a circumstance).
In all the modeled projections (above and below), you’ll notice the various econometric models begin by figuring inflation will be right at or near the 2% target – that’s the “anchored” assumption. And then as the projected year itself draws near, the estimates for inflation inevitably take a dive.
And when they do, more often than not it’s been because of crude oil – demand, not supply. The years around Euro$ #3, poor Janet’s liftoff spoiled, were obviously among the larger of the forecast misses (particularly 2015; so much for that short 6-month grace period) because for much of the rest of the world it turned out really, really bad (the US instead merely flirted with recession just as Yellen’s FOMC voted for its first rate hike; the embarrassment caused them to put the rest on hold for an entire year).
You could tell something more was amiss, global dollar-wise, by the combination of the oil crash, the rising dollar exchange value, but more so behind it all what really happened on October 15, 2014 (in case you don’t remember, a buying panic in UST’s unambiguously indicating serious collateral problems becoming that much more serious).
But even when oil prices are rising, as they had been in 2018, for example, this has only meant a smaller miss (undershoot). Each and every year starts out believed to be the year to hit or modestly exceed 2%, only to fall some degree short because the FOMC models like the mainstream Economists who pour their subjective assumptions into them can’t figure out why WTI goes up or down nor when and how it does either one.
That’s why 2019 ended up more like 2015-16 than 2018 or 2014; Euro$ #4 showed up, May 29, 2018, reminiscent of October 15, 2014, and wrecked the situation just as Jay thought he had almost reached Janet’s previous threshold.
Right now, in March 2021, WTI is on a rampage (though one that may be cooling, if the re-emergency of 1-month contango is to be believed). The FOMC projections for calendar year 2021 have been adjusted accordingly; released today, these indicate the Fed’s statistical models are calculating a range of 2.2% to 2.4%; up from a range of 1.7% to 1.9% spit out back in December.
Yet, not even the models – nor the current Fed Chairman – believe this is the very thing they’ve been waiting for, that it will last beyond the next few months. Not only the same with oil prices, but more importantly the arithmetic of being compared (base effects) to the outright deflationary months of last year.
In other words, as Powell admitted today, the Chairman and the FOMC all believe the current rise will be “transient.” No joke.
Unlike Yellen in 2015, Powell in 2021 at least has the market on his side. Inflation expectations, as we’ve stated previously (“inverted” TIPS), absolutely indicate just this; short-run inflation breakevens (5s) have surged to 13-year highs, while the further out you go on the curve the less impressive expectations trade. By the time you end up in figuring where they might all be “anchored” long run (the 5-year/5-year forward rate), the market isn’t expecting anything other than the same sorts of target misses as each and every one of the calendar years over the last decade.
The smallest of transitory.
Maybe Powell is simply using reverse psychology here, or maybe he’s just tired of being on the wrong side of the market. Either way, the FOMC models are right back at pegging long run inflation rates around 2% – just awaiting the next oil-fueled drop off the same models won’t see coming.
One reason for the bond market’s ongoing, lengthening skepticism.
While the world has been told to focus on these short run inflation indications alone, it was, actually, the fine print written out in the FOMC’s statement (Implementation Note) which might be the only piece worth paying much attention to (I’ve highlighted the key sections):
“Effective March 18, 2021, the Federal Open Market Committee directs the Desk to:
• Undertake open market operations as necessary to maintain the federal funds rate in a target range of 0 to 1/4 percent.
• Increase the System Open Market Account holdings of Treasury securities by $80 billion per month and of agency mortgage-backed securities (MBS) by $40 billion per month.
• Increase holdings of Treasury securities and agency MBS by additional amounts and purchase agency commercial mortgage-backed securities (CMBS) as needed to sustain smooth functioning of markets for these securities.
• Conduct repurchase agreement operations to support effective policy implementation and the smooth functioning of short-term U.S. dollar funding markets.
• Conduct overnight reverse repurchase agreement operations at an offering rate of 0.00 percent and with a per-counterparty limit of $80 billion per day; the per-counterparty limit can be temporarily increased at the discretion of the Chair.
• Roll over at auction all principal payments from the Federal Reserve’s holdings of Treasury securities and reinvest all principal payments from the Federal Reserve’s holdings of agency debt and agency MBS in agency MBS.
• Allow modest deviations from stated amounts for purchases and reinvestments, if needed for operational reasons.
• Engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency MBS transactions.“
These central bankers don’t pay any mind to collateral for things like repo (both UST and MBS), but here it sure sounds like they’re anticipating the possibility of “something” causing problems at the short end of the curve. This increase to the reverse repo “window” is a very clear signal that officials are getting a bit nervous as bill yields drop very close to zero (the RRP is supposed to be a floor).
Dollar rolls and MBS, where have we heard that before?
Unfortunately, as is clear in this directive, the central bank still looks at everything from the cash side exclusively. And while the RRP theoretically amounts to a window for renting back collateral from the Fed it has harmfully taken away from the system via QE, that’s not really what officials are after; their concern, as always, is money market rates violating policy floors and boundaries they’ve set rather arbitrarily.
What happens if/when the 4-week bill drops negative anyway despite these changes to technical policy implementation? It wouldn’t be the first time bills have violated the RRP simply because the RRP is, sorry, useless for these purposes; has been from its very beginning.
And that is why oil prices time and time again have ended up spoiling the inflation fiesta before it ever truly gets underway (exactly what TIPS is betting on today). Not transitory, global dollar keeping a lid on the global economy thereby depressing demand over time. The biggest contribution to these dollar shortage(s) – really a rolling variable dollar shortage that right now isn’t as bad as last year’s (reflation) – is typically a collateral problem which is indicated best by extremely high demand, to the point of pushing rates underneath any “floor”, for its best instruments.
All of these things are indeed related no matter which way whichever Fed Chairman happens to use the word “transitory” or any others like it.
In short, no wonder the TIPS market is inverted; commodities may be rampaging, but other the supply squeezes behind it and the base effects upon the CPI, what’s legitimately different? The Federal Reserve’s models don’t think there is anything and only because they can blame COVID this time.
Even the FOMC right here recognizes the symptoms (sadly not their cause) of what could be the seeds of the next, perhaps inevitable Euro$ #n. That, not this same ol’ inflation nonsense, nor the inverted use of transitory, is the real statement.