“The Federal Reserve Needs New Thinking. Its models are unreliable, its policies erratic and its guidance confusing. It is also politically vulnerable.” Former Fed Governor, Kevin Warsh.
“The Great Unraveling. Years of Fed Missteps Fueled Disillusion With the Economy and Washington.” Main headline, Wall Street Journal.
There comes a point, as in 2008, when the consensus view that “everything is fine” begins to collapse. That is clearly what happened last week, even before Fed Chair, Janet Yellen, gave her views on the outlook to the Fed’s annual Jackson Hole meeting in Wyoming.
Long-time readers will remember that Warsh was the only Fed Governor in recent times to take a realistic view of the post-2008 outlook, noting back in 2010:
“Broad macroeconomic policies have not changed direction in the past several years. But change they must if we are to prosper. We can no longer afford to tolerate economic policies that are preoccupied with the here and now. Chronic short-termism in the conduct of economic policy has done much to bring us to this parlous point.”
His criticism today adds a new dimension, arguing that the Fed:
“Appears in thrall to financial markets, and financial markets are in thrall to the Fed, but only one will get the last word. A simple, troubling fact: From the beginning of 2008 to the present, more than half of the increase in the value of the S&P 500 occurred on the day of Federal Open Market Committee decisions.”
Ms Yellen’s own speech at Jackson Hole confirmed that the Fed has no real idea where interest rates will be even in the next 12 – 18 months, when she announced that their favoured FRB/US economic model :
“Shows a 70% probability that the federal funds rate will be between 0% – 3.25% at the end of next year and between 0% – 4.5% at the end of 2018.”
Her speech laid great stress on the importance of the Fed providing markets with”forward guidance” on its likely policies. But clearly, the Fed’s cherished model is completely failing to provide this guidance, if it can only provide a two-thirds probability of even such a wide range of outcomes.
POLICYMAKERS NEED TO FOCUS ON REAL-LIFE DATA
The problem is that most policymakers prefer to spend their time playing with their economic models, and worrying about the outlook for financial markets, rather than talking to people in the real world. Thus they ignore the evidence provided by the chemical industry – which is easily the best leading indicator for the global economy:
□ July data from the American Chemistry Council shows that capacity utilisation has fallen every month this year
□ Yet companies continue to expand capacity, assuming that growth will return to promised levels
□ As the chart shows, this means that surplus capacity has now reached 26.7%
□ This level of surplus is very bad news for companies’ pricing power and future corporate earnings.
□ It also suggests the Fed’s belief that inflation is about to rise rests on very shaky ground indeed
We know from experience that today’s policymakers remain in complete Denial about the impact of demographic change on the economy. So we cannot expect their approach to change in the short-term. But it is very disappointing that they still refuse to take account of the evidence from the chemical industry about developments in the real world.
Unfortunately, the Jackson Hole meeting confirmed that they prefer to stay within their own comfort zones, even though their policies are clearly failing to produce the promised results.
WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 53%
Naphtha Europe, down 54%. “European refinery margins have come under increasing downward pressure on an escalation in Atlantic Basin inventory levels.”
Benzene Europe, down 52%. “Buyers retreating this week amid a sense that prices would see further erosion”
PTA China, down 41%. “Buying sentiments were subdued, as downstream end-users had already started shutdowns of polyester units.”
HDPE US export, down 27%. “ Traders reported resistance from end-users, which dragged down the high-end prices”
S&P 500 stock market index, up 11%
US$ Index, up 17%