Unambiguous Signals Disregarded

By Doug Noland

May 20 – Bloomberg (Susanne Walker Barton): “Treasuries fell, heading for their biggest weekly drop since November, as Federal Reserve officials indicated they’re considering a June interest-rate increase should economic data remain steady… A measure of volatility in the $13.4 trillion Treasury market rose Thursday to the highest level in more than a month. Investors were caught off guard by the hawkish tone of Fed communications, lulled into complacency amid signs of sluggish global economic growth.”

I’ll assume the FOMC would prefer to boost rates another 25 bps. They seek to at least appear on a path of “normalization,” dissatisfied with the “one and done” tag. Perhaps they have also become more attentive to the risks associated with prolonged near-zero rates for banks, insurance companies, money funds and the financial industry more generally. Recent economic data would tend to support a more hawkish bent, with a firming of GDP and inflation trajectories. I’ll stick with the theme that currently the key economic dynamic is neither growth or recession, but instead major imbalances and various boom and bust dynamics.

Members of the FOMC have voiced unease with market expectations having of late diverged from Fed thinking. The Fed expects a series of rate increases, yet the markets anticipate little movement on rates. The FOMC is “data dependent,” and sees economic fundamentals supporting a move toward a somewhat more normalized rate environment. Markets, on the other hand, see global market fragility and a Federal Reserve held hostage by unstable securities markets (and a “risk off”-induced “tightening of financial conditions”). The markets’ perspective is certainly supported by the Fed’s repeated skittish responses to any evolving “risk off” dynamic.

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Oil’s Rise May Flip Fed Script

By Chris Ciovacco

Oil’s Rise May Flip Fed Back To “We Plan To Raise Rates” Script

The Federal Reserve is due to release their next formal policy statement April 27 at 2:00 pm ET

Fed’s Constant Assistance Is A Two-Sided Coin

The Fed stepping in to assist financial markets is not particularly new or surprising but with a dual mandate that includes keeping inflation in check, the central bank’s “bailouts” cannot go on indefinitely. The recent Fed-assisted rise in crude oil impacts inflation expectations, which brings to mind the Fed’s Jackson Hole keynote address by Stanley Fischer:

“Because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2% to begin tightening.”

In 2016, thus far, the Fed has been content to keep rates hovering above zero. By reviewing how they decided to put off any additional rate hikes and the impact on inflation expectations, we can understand why the Fed’s market-friendly stance has limits, which may begin to adversely impact asset prices in the not too distant future.

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