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New Federal Reserve Paradigm
US equity indexes staged a sharp positive reversal since last Thursday morning following the tragic murder of British MP Jo Cox, subsequent currency market moves, and polling indicating Brexit is less likely.
Financial markets abhor uncertainty and there are few things more uncertain right now than the fate the Brexit referendum so it is intuitive that polling favoring the status quo supports higher equity prices. However, there are other forces at work that may prove much more volatile to US markets than the potential outcomes of the Brexit referendum.
Early Friday morning June 17, James Bullard, President and CEO of the Federal Reserve Bank of St. Louis, discussed a point paper with potentially huge market implications: The St. Louis Fed’s New Characterization of the Outlook for the U.S. Economy.
Overview
The Federal Reserve Bank of St. Louis is changing its characterization of the U.S. macroeconomic and monetary policy outlook. An older narrative that the Bank has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative. The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes. The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit. Regimes are generally viewed as persistent, and optimal monetary policy is viewed as regime dependent. Switches between regimes are viewed as not forecastable.
The upshot is that the new approach delivers a very simple forecast of U.S. macroeconomic outcomes over the next 2 ½ years. Over this horizon, the forecast is for real output growth of 2 percent, an unemployment rate of 4.7 percent, and trimmed-mean PCE inflation of 2 percent. In light of this new approach and the associated forecast, the appropriate regime-dependent policy rate path is 63 basis points over the forecast horizon. The discussion below describes how this regime could be upset by switches in fundamental factors that may cause changes in the recommended policy path setting.
The source and timing of the paper’s release are curious. Among money managers and traders that follow the Fed few of them I talk to hold Mr. Bullard in high regard. He is a very visible President and known for moving markets during interviews, especially during swift equity market corrections. He is alternately known as the Chairman of the Federal Open Mouth Committee.
The St. Louis Fed is best known for its Federal Reserve Economic Data (FRED) website. Ricochet Contributors and Members frequently cite FRED when writing on economics. I’ve not previously considered Mr. Bullard or the St. Louis Fed a go to source for long term Federal Reserve policy guidance. Historically, that has been the purview of the Chairperson or the NY Fed.
The document was posted to the St. Louis Fed’s website Thursday night and Mr. Bullard appeared on CNBC Friday morning to discuss it dropping a bombshell in contrast to his previous appearances. Mr. Bullard indicated the FOMC raising short-term rates at most once between now and 2018. This apparent new commitment to more accommodative policy published in writing and contradicting previous protestations of Loretta Mester of Cleveland and Ester George of Kansas City is a market bombshell the short-term effects of which are muddled with the Brexit Referendum.
The release late Thursday night and absence of formal introduction and press conference raises many questions as to how much this document is James Bullard freelancing and how much of it is Federal Reserve endorsed policy. That he issued it in writing lends credibility that this may be formal Federal Reserve policy.
Federal Open Market Committee Chairwoman Janet Yellen testifies before the Senate, Tuesday, June 21, and the House of Representatives Wednesday, June 22. It will be interesting to see if she refers to Mr. Bullard’s new regime document or if she is questioned about it. Releasing the paper so close to her testimony leaves Congress little time to prepare interrogatories on the matter.
Expect more than usual volatility as this paper is factored into the markets and Mrs. Yellen testifies. Be careful out there.
Disclosure: No Positions.
Published in General
I disagree. I think our next crisis will be state and municipal bonds. But I’m better at long-term forecasting — my short-term forecasts are worthless.
I pull up the website and see BrentB67 on the front page.
Sign of the coming apocalypse?
It’s a bearish sentiment indicator. Or maybe a bullish one. I’ll let you know.
That’s more of an observation than a prediction. That crisis has already begun.
The poor and middle class are just going to have to suck it up for a few more years while the upper end of the investor class consolidates its position.
Regardless of whether he is right or wrong – that website! My retinas!
I’ve been waiting for one of these posts of yours that didn’t include your standard disclaimer. Now I can invest and hold you responsible for giving me advice!
All I have to do is find something resembling a recommendation above…
Hah. Since I didn’t mention a specific instrument no disclaimer.
Anytime I write about the Fed the blanket recommendation applies: Long bullets, canned goods, and bottled water.
OK. So I’ve liquidated most of my stock positions today. I still have a good amount, but prices were just too good to pass up. It allowed me to bank some 100% gains (excluding 5 years of dividends) since the 2009 bottom that I think should be taxed at 0%.
For the people on the other side of my trades, I don’t know what they’re thinking. There may still be some room on the upside, but I wouldn’t want to start from near all time market highs. You’re in bigger fool territory at this point.
Let’s see what tomorrow brings. I don’t know if you’re right or wrong, but I know people who are sure they know are usually fooling themselves.
I’ll be satisfied even if things go higher. It felt right to me, and I needed to sell in order to change my allocations anyway.
Remain is priced in the market. A remain vote will cause maybe a slight pop at the open if Remain prevails.
The new paradigm is an uncertain and accommodative Fed. How that gets priced in remains to be seen.
Accommodation is generally bullish, but this is starting to look desperate.
Right, things probably aren’t going to go much higher if things go as expected, things could go much lower if there’s a surprise. I’ve liquidated around half my stocks so I’m taking the strong fence-sitting position. I’ll rebuy stocks in a couple days once my trades settle, but I’m getting out of US stocks and into emerging markets since the former is arguably significantly overpriced and the later has been flat to negative over the last decade.
I’ve also started a small position in long treasuries, more for lowering volatility rather than expected gains. I expect them to lose a little bit over the next decade.