QT1 Will Lead to QE4

by Jim Rickards, Daily Reckoning:

There are only three members of the Board of Governors who matter: Janet Yellen, Stan Fischer and Lael Brainard. There is only one Regional Reserve Bank President who matters: Bill Dudley of New York. Yellen, Fischer, Brainard and Dudley are the “Big Four.”

They are the only ones worth listening to. They call the shots. The don’t like dots. Everything else is noise.

Here’s the model the Big Four actually use:

1. Raise rates 0.25% every March, June, September and December until rates reach 3.0% in late 2019.

2. Take a “pause” on rate hikes if one of three pause factors apply: disorderly asset price declines, jobs growth below 75,000 per month, or persistent disinflation.

3. Put balance sheet normalization on auto-pilot and let it run “on background.” Don’t use it as a policy tool.

Simple.

What does this model tell us about a rate hike in December?

Disinflation has been strong and persistent. The Fed’s main metric for this (core PCE deflator year-over-year) has dropped from 1.9% in January to 1.4% in July. The August reading comes out on September 29. This time series is moving strongly in the wrong direction from the Fed’s perspective. This is what caused the September “pause” (which we predicted for readers last March).

After seven months of decline, one month of increase, if it comes, will not be enough to get the Fed to end the pause. It would take at least two months of increases to change the Fed’s mind.

That’s unlikely given the impact of Hurricanes Harvey and Irma. Those effects may be temporary, but they come at exactly the time when the Fed was looking for a turnaround in core inflation. They won’t get it. The pause goes on.

How do I know this?

For one thing, the Fed explains this all the time. It’s just that the media won’t listen; they’re too busy chasing dots.

But this was also explained to me in detail by the ultimate Fed insider. I call him, “The Man Without a Face,” and I identify him by name in chapter six of my New York Times bestseller, The Road to Ruin.

It’s true that Stan Fischer is leaving the board soon, but the White House has been in no hurry to fill vacancies. The Big Four will still be The Big Three (Yellen, Dudley and Brainard) when the December meeting rolls around and the analysis will be the same.

Eventually the markets will figure this out. Right now, markets are giving a 70% chance of a rate hike in December based on CME Fed Funds futures. That rate will drop to below 20% by Dec. 13 when the FOMC meets again with a press conference. (There’s another meeting on Nov. 1, but no one expects any policy changes then).

Now, with respect to quantitative tightening (QT), the same way they tapered QE, they’re going to “taper” QT. This time however, they’re going to taper upward. Meaning they’re going to go from $10 billion a month not being rolled over to $20 billion, $30 billion, etc.

Eventually, the amount of securities they don’t roll over will go up until the balance sheet controlled by the Fed comes down to the targeted figure. The projection is that it could take five years to achieve. The problem is we might not make it that far before the entire system collapses.

We’re in a new reality. But the Fed doesn’t realize it.

Here’s what the Fed wants you to believe…

The Fed wants you to think that QT will not have any impact. Fed leadership speaks in code and has a word for this which you’ll hear called “background.” The Fed wants this to run on background. Think of running on background like someone using a computer to access email while downloading something on background.

Read More @ DailyReckoning.com

/Source

SGT