The Fed released the minutes of its October meeting last week. Because of the holiday, most of us missed it. But there was some important stuff here that reaffirmed my view of what the Fed is doing and why.
So here’s a look at what the Fed says was said at the meeting–not what was actually said. The meeting minutes are propaganda, designed to get across the Fed’s main narrative. The actual words of the participants (supposedly) won’t be released until 5 years hence. The Fed wants you to know what it wants you to know. Usually that’s not the same thing as what it actually knows, but it’s still important.
As always, their real message is cloaked in doublespeak and obfuscation.
And that message has direct implications for your money (which is why they don’t want you to understand it).
Fortunately, your trusty Fed watchdog (me!) is here to translate for you…
Reading Between the Lines: Markets Are Not As Solid As They Seem
The first section of the minutes is devoted to a review of the economy prepared by Fed staff economists. They initially noted that inflation as they define it remained below 2%.
Here’s what the Fed staff said.
…total consumer price inflation, as measured by the 12‑month percentage change in the price index for personal consumption expenditures (PCE), remained below 2 percent in September and was lower than early in the year.
Of course, their definition of inflation doesn’t include housing inflation, which would increase the index that they follow, the PCE, by about 1%. The PCE uses other suppressive measures as well which results in an understatement of consumption goods and services inflation. Likewise, the standard “inflation” measures don’t include asset prices, as if somehow, the increase in asset prices are not a representation of inflation.
Next they looked at the other half of the Fed’s Congressional mandate-employment. They noted solid trends there, despite the hurricane related disruptions. Then they noted another inflation measure which better represents general inflation, but which the Fed doesn’t consider in its inflation judgment. They also made an excuse for some of the increase, when in fact the impact of that excuse was infinitesimal.
Recent readings showed a modest pickup in growth of labor compensation. The employment cost index for private workers increased 2-1/2 percent over the 12 months ending in September, a little faster than in the 12-month period ending a year earlier. Increases in average hourly earnings for all employees stepped up to a rate of almost 3 percent over the 12 months ending in September; however, a portion of that acceleration possibly reflected a hurricane-related reduction in the number of lower-wage workers reported as having been paid during the reference week in September.
Next, the economic staff reviewed the financial markets. Just like media pundits, Fed economists look for reasons that the markets did what they did. Somehow, they always find them, and make pronouncements without a scintilla of factual evidence. This is what we commonly call the market’s “narrative.” Whether fiction or factual doesn’t matter. The important thing is that this is what the market manipulators want you to think. You need to be aware of that.
Movements in domestic financial asset prices over the intermeeting period reflected FOMC communications that were read as slightly less accommodative than expected, economic data releases that were generally better than anticipated, and market perceptions that U.S. tax reform was becoming more likely. On net, Treasury yields increased modestly, U.S. equity prices moved up, and the dollar appreciated.
There was no discernible reaction in financial markets to the widely anticipated announcement of the FOMC’s change to its balance sheet policy. [emphasis mine]
The last sentence there is the most important. Traders and investors are ignoring the Fed’s plan, now in the early stages of implementation, to shrink its balance sheet and drain money from the banking system. It will do so at an accelerating rate over the next year, reaching $50 billion per month drained from the system starting in October 2018. That’s draconian.
As the Fed ratchets up toward that goal, the markets will come under increasing pressure. That’s simply because there will be less money around to fuel the demand for investment securities.
The staff then reviewed the market’s perceptions of Fed communications. This is a dog chasing tale (sic) exercise.
Communications by FOMC participants were also seen as reinforcing expectations for continued gradual removal of policy accommodation. The probability of an increase in the target range for the federal funds rate occurring at the October-November meeting, as implied by quotes on federal funds futures contracts, remained essentially zero; the probability of an increase at the December meeting rose to about 85 percent by the end of the intermeeting period.
The issue here, as I’ve repeatedly emphasized, is that the Fed’s current method of raising interest rates is not at all restrictive. Market insiders, including Primary Dealers and big banks know this.
When the Fed increases IOER (interest on excess reserves), it is actually more accommodative, not less. It’s a direct subsidy to the banks that costs them nothing. It lowers their cost of funds and increases their cash flow. It gives them no incentive whatsoever to raise lending rates to borrowers. However, if borrowers perceive that they need to pay more, they’ll pay a little more. It’s a shell game. Useless and beside the point. The only thing that matters here is that the Fed is pulling money out of the banking system and extinguishing it via its program of “normalization” of its balance sheet.
This process has barely started and has had no impact so far, but it will, particularly after January when the Fed ratchets up from $10 billion per month in drains to $20 billion. Every quarter it will increase that by another $10 billion, so that by next October, the Fed will start pulling $50 billion per month out of the system.
There was a lot more of this meeting – and I’ll get the rest of my notes to you before too long – but for now, I want to cut to the most important kernel of the entire report.
The Fed’s Message to Market Insiders Is A Lot Different than Its Message to You
In light of elevated asset valuations and low financial market volatility, several participants expressed concerns about a potential buildup of financial imbalances. They worried that a sharp reversal in asset prices could have damaging effects on the economy…
I have repeatedly reported that the Fed’s real concern isn’t consumer inflation. That is not why the Fed has begun tightening. It has begun to tighten policy because it is concerned about the stock market bubble. I would bet that this subject got far more attention in the meeting than it did in the minutes. The Fed wants to note it, but doesn’t want to engender a panic reaction. So it sort of mentions it in passing.
A few participants mentioned the limited reaction in financial markets to the announcement and initial implementation of the Committee’s plan for gradually reducing the Federal Reserve’s securities holdings. It was noted that, consistent with that limited response, market participants had characterized the Committee’s communications regarding the balance sheet normalization program as clear and effective.
That’s just BS again. They are worried about managing the effects of tightening. The market hasn’t reacted because no funds have been pulled from the system yet. That will only start as a trickle in December.
After several more pages of gibberish and gobbledygook, they concluded thus.
Here’s the secret message. Blink and you’ll miss it.
With the balance sheet normalization program under way and with the balance sheet not anticipated to be used to adjust the stance of monetary policy in response to incoming information in the years ahead, members generally agreed that the statement following this meeting needed to contain only a brief reference to the program and that subsequent statements might not need to mention the program.
There are two crucial messages in that statement. I would view it as insane, if I didn’t know better. This is manipulative propaganda. The message to you is, “Nothing to see here. Move along!”
The message to the Fed’s client Primary Dealers and other market insiders is. “We are going to do this. We will be pulling money out of the system come hell or high water. Get your ducks in a row. Build your short positions.”
With that in mind, I recommend continuing to sell small portions of your stock and bond portfolios systematically, with the goal of reaching approximately 60-70% cash, or more or less depending on your individual situation, by the end of the first quarter at the latest, and by the end of January if you have already had such a program under way for the past 2 months.
As for shorting the market, the time is growing close. For that call, I depend on technical analysis. I’ll give you a heads up here when the time comes and will also have recommendations on particular stocks and ETFs that I feature as short term trades on the short side in The Wall Street Examiner Pro Trader.
You can also look for short side recommendations from our colleague Shah Gilani at Wall Street Insights & Indictments.
The LAMPP Shows Time Is Running Out for Long Trades…
The long term LAMPP remains a hair above a red signal. The Treasury continues to issue large amounts of new debt and the Fed will start to settle fewer MBS purchases in December. It will also require the payoff of a small amount of Treasuries from its balance sheet in December. In January that amount will increase bringing the total amount to be drained from the banking system up to $20 billion from $10 billion.
If the Treasury continues to issue new debt at the current rate in December, as the TBAC has forecast, then the long term LAMPP should flash a red signal in roughly 5 weeks. That’s the first week in January. It wouldn’t be the first time the market has peaked in January.
The short term LAMPP remains red. This signal has appeared to be wrong, although for several weeks in September and October my short side trading picks in the Wall Street Examiner Pro Trader model trading portfolio were doing better than the longs.
That has not been the case over the past 2 weeks. Longs have outperformed. The stock market is running on fumes, apparently driven by foreign inflows, and increased use of margin and other types of leverage by traders. No doubt short covering has played a role in the rally as well. When this is exhausted, it’s likely to end with a thud.
In the meantime, I would not be buying long term positions. And while it has worked for the past couple of weeks, even short term trading from the long side will become increasingly risky over the next 3 weeks or so. When the Long Term LAMPP turns red, I would concentrate on trading from the short side.