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February 2015

The Fed Waited Too Long: Hear Comes Inflation

February 26, 2015 by EconMatters   Comments (0)

By EconMatters

CPI Core Shows Inflation

The drop in energy prices, had the knee jerk reaction that we were in a deflationary spiral, again markets get many things wrong on first blush. The drop in energy prices is inflationary in the overall economy, and today`s CPI report showed what a sophisticated analysis would forecast regarding inflation and the role that low energy prices play in the overall inflation equation. We are going to have a transfer from the food and energy components which rely heavily on energy costs into the core inflation reading as consumers have more money in their pockets for true discretionary spending, and all these components` prices are going to rise in the CPI Inflation Index.

Wages, Wages, Wages

What should really be worrying for the Fed is that wages have been spiking under the radar for 2014, up ahead of the overall inflation metric, and leading the way on inflation, and 2015 has seen an even greater surge in wage inflation, again you might not want what you wish for when it actually comes to fruition, with wages surging the Fed now has no choice but to raise rates, and raise them fast!

Walmart: Canary in the Coal Mine

It should have been a warning sign to the Fed when Walmart of all people voluntarily raises wages across the board for its employees, they aren`t doing this out of the kindness of their heart. If one takes a look at the JOLTS numbers, and the competition for employees in a tightening labor market, wages are going to have to rise to compete for the available labor pool. 2015 is going to be the year of the wages, and inflation is going to blow through the Fed`s 2% target towards the end of the year once the bad energy comp components come out of the data set.

Lower Energy Costs are Inflationary to the Overall Economy

The drop in energy made everyone complacent on inflation, and everyone just assumed that inflation was never going to rear its ugly head again, but that was a mistake because we have had some elevated inflation numbers in the past 20 years with much less money printing, much higher Fed Funds Rates, and much lower overall energy costs coursing through the entire economic system. So when you look at the employment numbers for 2014 and 2015 it was only a matter of time before core inflation started picking up, stealthy at first due to the drop in energy prices, but slowly gaining steam under the radar, and the longer the Fed waits on raising rates the more they are going to have to raise rates the back half of 2016.

Follow the CPI: This is where the Demand is for Employees

This inflation surge is going to be led by wage inflation, which is to be expected given the tightening labor market, as lower fuel costs serve as a major economic stimulus net in the overall economy; leading to demand for workers in all the areas of the economy where this newfound stimulus is going, namely the services, manufacturing, and entertainment sectors of the economy.

Retail Never Voluntarily Raises Wages Across the Board

By the time the markets and the Fed realize that inflation is a problem it is too late, today`s Core CPI reading ought to be the second warning signal for the Fed, the first being Walmart raising wages across the board for employees, that just doesn`t happen in my lifetime for the retail sector, they go out of their way to keep employee wages down as a cost component because margins are so tight, management is even incentivized to keep employee costs extremely low in many retail environments.

The fact that Walmart raised wages in the manner that it did ought to have alerted the Fed that something is going on in the underlying employment dynamics of the labor market that they aren`t addressing with their current ZIRP stance. By the time they realize that the labor market is so tight that employers are voluntarily raising wages across the board it is far too late, you are officially behind the curve as the surge in wage inflation is signaling loud and clear.

The Inflationary Cycle & the Vicious Cycle of Surging Wages in a Tight Labor Market

We were all expecting inflation to be problem with ZIRP, everything goes in cycles, wages were the last component to gain any footing in the inflation equation, but once they get started it becomes a self-reinforcing dynamic where higher wages lead to employees quitting lower paying jobs to move to higher paying jobs, employers then start competing for employees leading to more wage increases, all of which leads to a competitive fight over the existing available labor pool where the employees have the upper hand, something that hasn`t occurred for 8 plus years of the latest economic cycle. Well Janet Yellen you finally got your request granted in terms of wanting to see some wage inflation, one should be cautious what one wishes for because now it means you have no further excuse for not raising rates ASAP!

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Janet Yellen Encourages More Levered Risk Taking in Markets Tuesday

February 25, 2015 by EconMatters   Comments (0)

By EconMatters

Risk Taking Tuesday

Federal Reserve Chair Janet Yellen testified before the Senate banking committee on Tuesday, and again the end result from the market`s point of view was to borrow even more money, and buy risk assets in the form of bonds and stocks.

Bonds Have Become Speculative Risk-On Assets

When bonds go up when stocks go up, that`s all you need to know that under the Free Money Fed that Bonds have changed from being traditionally risk averse assets, or assets to hedge against risk during bad times or portfolio balancing, they have now become ultra-aggressive risk assets to buy just like stocks for price appreciation and yield chasing plays. How you can tell is by what other assets like the important funding currency crosses do, and today`s action just screamed borrow more money via the various carry trade crosses, and buy the risky assets like overpriced bonds and stocks because to the market Janet Yellen gave them the all clear for at least TWO MORE MONTHS.

What Yellen Said…and The Market Believed Anyway?

The ironic part is the market`s interpretation and what Janet Yellen actually said is such a large gap that you could float and iceberg through it. She said the Fed will most likely not raise rates for two more Fed meetings (March and April) the market interpreted this as no rate hikes for 2015!

June (25 Basis Point) Rate Hike 95%

It is interesting that Janet Yellen is starting to discuss elevated financial metrics in financial markets, but yet at the same time not be aware of how her actions and statements are interpreted as far more dovish than her literal statements, nothing she said today postponed a June Rate Hike, in fact, if anything it looks like that June Fed Meeting is when the first rate hike will occur, being that it is a quarterly meeting with a formal press conference attached.

Hawkish Tone Needed From Yellen

So if Janet Yellen is concerned with elevated financial valuation metrics on one hand, and after she gets done speaking about Fed policy, the market interprets her as even more dovish, and the all clear is out to take more risks, where do these same elevated financial valuation metrics stand after her Senate testimony? In effect Janet Yellen just talked up more leverage, more risk taking, and blew bigger bubbles in both stocks and bonds today with her Senate testimony.

It Takes a lot longer than 2 months to liquidate positions in over levered trades at a decent price

The market might want to rethink the not raise rates for 2015 interpretation regarding Yellen`s Senate testimony, and stick to the literal statement, two fed meetings. Remember, one way to look at this is two months before the next Fed Rate Hike, but does that represent a buying or selling opportunity, given where bond and stock prices and valuation levels are right now? Remember if it is in fact two months this means investors have to sell everything they buy over the next two months, plus all the other ‘pricey merchandise’ they have been buying for the last 7 plus years of ZIRP.

Rationalizations, Risk Taking & No Rate Hikes for 2015

Today`s Yellen testimony seemed to just about cement a June Rate Hike by the Federal Reserve, but when market participant`s just look for rationalizations to do what they wanted to do all along which is to borrow more money, take more risks, and push more assets up, and deal with the consequences long after the fact, yeah two months does indeed sound the same as No Rate Hikes for 2015!

All Going To End Very Badly

This is just all going to end very badly, and Janet Yellen is just as much to blame as the over aggressive traders taking on all this risk and making the financial system extremely vulnerable to tail-risk selling episodes that destabilize the entire global financial market. Again Janet it is nice to know that you are paying attention to elevated financial valuation metrics, just so you know you just encouraged more risk taking today with your testimony, good job cheering on the irresponsibility, making valuations even more extreme and unsupportable, and setting the stage for the next financial crisis.

Art Imitates Life: Didn`t we see this movie already with the Financial Crisis?

Janet Yellen and the entire Federal Reserve should be forced to watch the movie Margin Call as many times as it takes to understand the role that Fed Policy plays in relation to Trader`s loading up on unsupportable risky assets to such a degree, that when the bubble bursts, the entire system`s stability is at stake in the process.

Bubble Methodology & Solutions

The best goal is to never build bubbles in the first place with monetary policy, the next goal if the first one is already violated, is to recognize the bubble, and Janet seems to be recognizing these facts with her valuation comments, this should be followed by slowly letting some of the air out of the asset bubbles.

There She Blows…The Bubbles Keep Getting Bigger and Bigger

But instead with every statement opportunity of the last six weeks, and she has to realize that she has to talk more hawkish given her dovish reputation for markets to even consider the potential for taking the punch bowl away, and given financial markets propensity for taking risks in general; dovish or statements that could be interpreted as dovish, are only building the bubbles bigger, and exacerbating the problem of unsustainability that we are nearing right now with regards to asset prices.

I Guess We Are Favoring the Crash Scenario for Bubble Containment Strategy

In short, Janet Yellen is setting the stage for the Crash Scenario of “Asset Repricing”, instead of slowly letting the air out little by little, the air comes out all at once, and there is a big bang of a burst where everybody realizes that the shit has hit the proverbial fan – or the moment in Margin Call where the analyst realizes just how offside his firm is with unsustainable, levered assets that will Bankrupt the entire firm with just a normalized correction in asset prices. The last thing Janet Yellen needs to be doing right now is cheerleading more risk taking on behalf of financial market participants!

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