Michael Darda Annihilates the Fed Hawks in Latest Note

I really enjoyed this note. MKM is talking rate equilibrium and making a farce out of our Federal Reserve, who no longer possesses the intellectual upper hand in these debates. Sad but true.

Executive Summary: It’s pretty clear at this point that the Fed will not be hoisting short rates up today and perhaps not even in July. It’s also equally obvious that the Fed desperately wants to raise rates in a sustainable way, despite market doubts that it will be able to do so. Is market incredulity justified, or simply a game of chicken that the Fed keeps losing? The market is skeptical — rightly, in our view — because it knows that the Wicksellian equilibrium rate remains depressed and, thus, the Fed has very little room to move rates up without putting its inflation target (and the business cycle) at risk. Indeed, both the indexed bonded market and survey-based measures show the Fed’s credibility in achieving its 2% PCE objective remains in serious doubt. And when you are near zero on short rates that is a serious problem indeed (and no, raising rates earlier would only have slowed the economy more, which would make the problem worse, not better). Our equilibrium short rate model (based on the prime age EPR and a risk premium) still suggests a near term rate hike would be a mistake. This is, essentially, the same message that our base/NGDP model is sending: the taper and end of QE were a de facto tightening that should be expected to keep NGDP growth, at best, near the low end of the six year range. This is the big picture, not the current myopic focus on a one quarter bounce in GDP that is not likely to be sustained. Indeed, business loan delinquencies are on the upswing, something that preceded a rising unemployment rate going into the early 1990s, early 2000s and 2007-2009 downturns. If this doesn’t make the hawkish hucksterism coming out of various financial organs seem silly, it should. Is the median FOMC member aware of this chart? We sure hope so, but if recent (verbal) performances are indicative of future results, we wouldn’t count on it. Happy Fed Day.

Well done.