MAY 18, 2018
This is what happens when you prop up weak markets and make them appear strong.
Inflated risk asset prices are not indicative of fundamental economic strength. They’re indicative of a whole lot of ZIRP cash sloshing around in seek of investment return. An effort to stem inflationary pressure the Fed has created itself will simultaneously choke out an already-sputtering economy.
The Fed is tightening into weakness and will reverse course by pausing rate hikes later this year.
When that happens, important trends in stocks, bonds, currencies and gold will be thrown into reverse.
Outwardly, the Fed is sanguine about the prospects for monetary normalization. Both Janet Yellen and new Fed chair Jay Powell have said that interest rate hikes will be steady and gradual.
In practice, this means four rate hikes per year, 0.25% each, every March, June, September and December, with occasional pauses prompted by strong signs of disinflation, disorderly markets or diminution in job creation.
Lately job creation has been strong. And inflation has picked up. But it’s been spotty. The Fed still faces headwinds in achieving its inflation goal.
The Fed is going to find out the hard way that raising rates and reducing the balance sheet will slow the economy. I believe that will ultimately lead to another flip-flop and the Fed will once again loosen.
When the market sees that the Fed has decided to flip from tightening to an easing policy, look for increased volatility — and more corrections.