Déjà Vu All Over Again

“It’s déjà vu all over again.” – Yogi Berra.

We’ve seen this story before. The new Federal Reserve chair gives a speech. Investors try to make sense of it.

They place bets that he’s going to steer the Fed one way. Then those bets fail.

By now, you may have guessed I’m talking about Fed chair Kevin Warsh’s recent speech at Jackson Hole.

In a tradition dating back more than 40 years, the Federal Reserve Bank of Kansas City hosts its annual Jackson Hole Economic Policy Symposium in Jackson Hole, Wyoming. The invite-only event includes Fed officials, heads of other central banks, and leading economists.

It’s also one of the most anticipated events in the financial world.

Everyone waits for comments from whoever happens to be the Fed chair at the time. They hang on every word, looking for any clues on how to position their portfolios.

So last Friday, investors from around the world hung onto every word he said. Hoping to guess what the Fed would do next.

These are investors and analysts who thought things would be easy with the new Fed chair. They thought the party would continue as it has for nearly 20 years now.

But Kevin Warsh had a surprise for them on his first day on the job. As I talked about back in July, Warsh gave them a gut punch instead.

On that first day in office, he told them the Fed wasn’t giving them any more clues. No more “forward guidance” – the practice of telling investors what the Fed was about to do with its policies. Including where interest rates were heading.

And he’s maintained that practice despite screeching from those same analysts who are having a hard time figuring out what comes next.

Fed chairs of years past made their job easy. Warsh told them to get back to work and figure it out on their own.

So far, they’ve gotten it all wrong.

Since Warsh took over, I’ve maintained the position that the Fed isn’t going to raise interest rates. It isn’t going to take a hammer to an already strained debt market. And especially to a job market that’s showing signs of stress.

That’s even with official inflation numbers staying above the Fed’s 2% target. Yet the annual inflation rate is still falling.

And still, the consensus view among Wall Street analysts right now is for the Fed to raise rates.

That’s despite many other data points that say otherwise. Like the Chicago Purchasing Managers Index (PMI), a monthly survey of business conditions in and around Chicago. It covers both manufacturing and non-manufacturing activity. So, analysts use it to gauge the health of the current economy.

If it’s above 50, that’s usually a sign business activity is expanding. If it’s below 50, it’s contracting.

Last month, the reading was 47.1. The forecast was 57.9. So, it was a big miss.

We can also look at payroll numbers. July’s non-farm payrolls fell by 23,000. That was against an expectation of about 80,000 job gains. Plus, we saw a revision to June’s numbers to a gain of just 20,000 jobs versus a consensus estimate of about 100,000.

The Fed is supposed to consider all this information. They see it. Just as we see it.

And analysts see it too. Yet they’ve predicted rate increases twice now. They’ve missed both times.

Why? Simple. They’re listening to Warsh’s speeches looking for the clues they want to hear. Not what he’s actually saying. Not what he’s doing. And not even considering the actual data.

When Warsh talks about how inflation isn’t easing as much as he’d like to see, they’re interpreting it as the Fed is about to raise rates. Which is nothing new at this point.

In his first speech as Fed chair, he said: “Our mandate at the Fed is to promote price stability and maximum employment.”

That speech had analysts tied in knots. Bank of America even went so far as to call for the Fed to raise rates three times this year. A call that I said was Wall Street’s worst this year.

In June, Warsh said: “We’ve missed [on inflation] for five years, and we’re going to fix that.”

That added fuel to the rate hike fire.

But when the June meeting rolled around, the Fed held rates steady.

Strike one.

In July, analysts got another chance to figure things out. Again, they predicted the Fed would raise interest rates. And again, they got it wrong.

Strike two.

Now after Jackson Hole, they’re going back to the rate hike well. Third time’s a charm? I’m not so sure.

Kevin Warsh’s speech at Jackson Hole wasn’t anything new. At least if you’ve paid attention.

He told the audience, “We must be confident that underlying inflation is moving to our objective, clearly and at sufficient speed. Otherwise, we have work to do.”

Analysts took that to mean interest rate hikes are coming. But again, I don’t think they’re paying attention.

Just as before, they’re taking Warsh’s comments as a commitment to raising interest rates. They see his speeches as hawkish – meaning he wants to rein in costs. And they should, because his speeches so far are hawkish.

But they’re missing something important. Being hawkish doesn’t mean the Fed has to raise rates. Keeping them steady has the same intended effect. Keep them higher for longer, and you’ll eventually see prices subside.

Instead, they’re still hanging onto the notion of forward guidance.

They’re not adjusting to this new reality. And it’s costing them dearly.

Now, I may be wrong. The Fed may hike rates when it releases its decision later this month.

Wall Street believes that’s going to be the case…again. Analysts are pricing in about a 60% chance of a rate hike.

But I’m not willing to bet on it. In fact, I’m sticking with my earlier call: there will be no rate hike.

Which means, for the consensus Wall Street view, it’ll be déjà vu all over again.

Plan accordingly.

Regards,

Editor, Strategic Trader