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| The woman who prints 16 Trillion US$ so far. |
In remarks last week that jarred the market, Yellen ruminated about the benefits of letting inflation run a little hotter than normal while allowing the unemployment rate to drop below the point that historically would trigger Fed tightening action. (Which means she will keep on printing trillions of US$ to lower the interest rates.)
To many observers, the comments were a clearly dovish signal that she favors a lower-for-longer approach when it comes to interest rates. But that kind of attitude could exacerbate tensions among Federal Open Market Committee members, in particular those who have been clamoring for rate hikes.
"Despite the fact that rates were not raised at the September FOMC meeting as we predicted, the truce at Federal Reserve has never been more tenuous and appears to be on the verge of an outright civil war," Doug Roberts, chief investment strategist at Channel Capital Research, said in a note. "The truce between hawks and doves is now being renegotiated."
Right now there are just three hawkish members of the 10 FOMC voters. They are Esther George, who often breaks from the dovish pack, along with Loretta Mester and Eric Rosengren, a recent addition to those pushing for higher rates. The dissenters worry that keeping interest rates too low could hasten a recession if the Fed is forced to act quickly on rates after inflation picks up, according to minutes from the September meeting.
"At this point there is a civil war, and the consensus is, the hawks are saying 'We'll allow you to raise rates very slowly, we just want you to start raising rates,'" -Doug Roberts, chief investment officer, Channel Capital Research.
In addition to the three "no" voters, Vice Chair Stanley Fischer earlier this week spoke on the dangers of low rates. "The limitation on monetary policy imposed by low trend interest rates could therefore lead to longer and deeper recessions when the economy is hit by negative shocks," Fischer said, according to the text of his remarks. Fischer did say the Fed needs to keep rates low and would be helped by stronger fiscal policy.
Yellen has only seen this level of dissent in her tenure once before, in December 2014. Should it continue or accelerate, the reverberations will be felt through the market. "At this point there is a civil war, and the consensus is, the hawks are saying 'We'll allow you to raise rates very slowly, we just want you to start raising rates,'" Roberts added in a phone interview. "What the new (consensus) will look like is being renegotiated. ... That, to me, is going to act as an overhang for the market."
Though the Fed professes independence, Roberts thinks the upcoming presidential election will sway policy. President Barack Obama has appointed consistently dovish Fed members. He reappointed Yellen's predecessor, Ben Bernanke, then named her in 2013 to chair the central bank.
Democrat Hillary Clinton has spoken comparatively little about the Fed during her campaign, but Republican Donald Trump has been critical of Yellen in particular. That could be a signal he would appoint more hawkish members, though he also has spoken in favor of low interest rates.
Wall Street itself is divided on the rates issue. Some worry that the current low-rate environment has generated capital misallocation and boosted asset values — stocks in particular — while penalizing savers and pensions and holding back economic growth.
In an analysis released Friday, Goldman Sachs economists see only limited benefits to following the "high-pressure economy" strategy, particularly when it comes to the primary malady, low productivity. "[I]t is hard to have great confidence in the productivity benefits of a high-pressure economy," David Mericle and Avisha Thakkar said in the report. The greatest benefits, they said, would come to low-wage workers who could see pay increases in a tighter labor market.
However, they did note the effects the debate could have on Fed unity. "Fed officials who believe that there is a clear trade-off between running a high-pressure economy and the expected duration of the expansion are unlikely to be persuaded by these benefits," Mericle and Thakkar wrote. "But for those who do not see as strong a link, the policy might look more like a trade-off between low-probability risks and low-probability benefits.
"We take last week's comments as a sign that this is a live debate on the FOMC, one that could have important implications for the pace of tightening next year and beyond."
Fed’s Fischer warns of the dangers of low rates
Fischer: Low rates can threaten financial stability. Federal Reserve Vice Chairman Stanley Fischer on Monday warned of the dangers of low rates. In prepared remarks for a speech at the Economic Club of New York, Fischer suggested that low rates can lead to longer and deeper recessions, making the economy more vulnerable.
He added they can also threaten financial stability, although the evidence so far doesn't show a heightened threat of instability. Fischer said the central bank has a limited ability to combat recessions because it does not control all the factors leading to depressed rates. His remarks contrasts with those of Fed Chair Janet Yellen on Friday, when she suggested that the Fed may want to run a "high-pressure economy" with low interest rates.
Though Yellen said it's useful to consider the benefits of such an economy, Fischer did not specifically relate his remarks to a preference for monetary policy. The policymaking Federal Open Market Committee hasn't approved an interest rate increase since December. However, pressure is building. Three FOMC members dissented at the September meeting, believing the committee should have raised it key funds rate a quarter-point.
The Fed's vice chair said technology and demographics are contributing to low rates, but are out of the Fed's control. Fischer said other reasons contributing to weak growth include productivity and labor force growth, an aging population, weak investment and weak foreign growth.
Stocks continued to hold lower, following Fischer's comments.
Hedge fund star Kyle Bass sees 'stagflation' coming in 2017
Bass, who made his name betting against subprime mortgages ahead of the 2008 financial crisis, warned that the combination will create an environment of "stagflation," a term that came into widespread use during the 1970s when both consumer prices and unemployment were on the rise.
From an investment standpoint, the Hayman Capital Management founder and CIO said the main advice is for investors to stay away from long-duration bonds. Inflation usually causes bond yields to rise and prices to fall, creating capital losses for investors.
To be sure, recent years have seen repeated calls for investors to avoid fixed income at the far end of the curve. However, the iShares 20+ Year Treasury Bond exchange-traded fund has had a stellar year, turning in a price gain of 10.2 percent as of afternoon Wednesday.
Economic growth indeed has been slow. Gross domestic product averaged just 1.1 percent growth in the first half of the year. Third-quarter growth is expected to be a bit better. Economists surveyed by Reuters put Q3 GDP at 2.6 percent, though the Atlanta Fed's forecast is for just 2 percent expansion, a number that had been as high as 3.8 percent.
Wages have nudged higher, with average hourly earnings up 2.6 percent on an annualized pace in September. The consumer price index, excluding food and energy, rose at a 2.2 percent pace in September.
Bass said he has few equity holdings,
so he had no recommendations on the stock market. However, he said his economic
call shouldn't be interpreted as a doomsday prediction for Wall Street. "I'm
not saying the market's going to crash," Bass said. "I'm just saying
it's going to have a real hard time generating positive real returns in the
next few years."
