Macro Brief: FOMC Minutes with a surprise and inflation expectations could start to rise

 

Wrote this piece post the FOMC March notes: http://www.tradingfloor.com/posts/fomc-minutes-less-than-the-liquidity-junkies-hoped-for-1545086186

 

But more importantly, the key sentence in the FOMC Minutes was the following:  (Source: Edmund W. Schuster: News from the Fed is moving the market)

 

"A potentially important debate emerged at the Fed at its policy meeting last month about the U.S. economy's growth potential, the minutes showed. Most economists believe the economy can grow by around 2.5% annually without causing inflation. If the economy's potential is less than that, that could mean that even a small amount of growth could push consumer prices higher and force the Fed to rethink its easy money policies."

 

Many believe that the U.S. economy has to grow at 3.0 - 3.5% just to absorb new entrants into the workplace.

 

Further, if there is a chance that inflation could tick up if growth exceeds 2.5%, then the chances of rapid growth above 3.5% seem unlikely. Usually there is a strong inverse correlation between inflation and economic growth.

 

 

This is big news and moves the needle on further easing away from “infinite cheap money” forever…..AND as I have state a few times: Velocity of money continues to be the key component in understanding the inflation risk: Good old economics states: M *V = P* Y, M is money supply, V is velocity, P is price level and Y is quantity of output.  This can be converted into: P = M* V/Y

 

With the math out of the way,  look at this chart from St. Louise FED which is the lending change year-on-year from all commercial banks:

 

 

Wow, banks in the US are lending – and the two major ways velocity changes is through loan demand – or losing faith in the purchasing value of the currency (Think Hyperinflation in Germany in the 1920s/30s….

 

It seems that in the “real world” we have for the first time a rising velocity of money potential through loan demands combined with easy monetary policy – leading me to conclude, again, inflation expectations have reached a low, and if anything, could start to increase, a sign would be steeper yield curve:

 

 

 

So how does this change the FOMC outlook and the liquidity junkies need for more? Not a lot for now- I still think the “path of least resistance” is lower rates, but it seems the “unconventional” is gone for now, or at least delayed and that in itself will make for an interesting talk on investment meetings this next week. The market now NEEDS a weak non-farm to get Bernanke and Dudley back into leaking their intentions(QE 3 to QE Infinite) to WSJ.

 

We, at Saxo, see a non-farm number in line with January and February, so no big down-side.

 

Note also the long term  channel I have addressed several times remains solidly in place:

 

 

 

Conclusion:

 

Market was clearly disappointed in the lack of dovishness – and the material change was on growth potential being changed DOWN to 2,5% down from 3,0% to 3,5% - that makes a huge difference and with the wrong assumption on the labor market from Bernanke(he believes in cyclical, we believe in structural), we are now for the first time in five years at risk for higher inflation expectations, that is the last thing the market needs, and probably why it will get it!

 

Strategy:

 

We still like US Dollar – a view we have held since late 2011 – access to capital, political stalemate(good for business), and higher innovation/productivity than Europe. We overall think the US Dollar is about to start major up cycle which will negate most of the loss seen since 2000 (EUR/USD @ 0.8400 in 2000) – there will many false starts, but the US is about to outperform relatively on growth although as Fed now realize from a lower level, but so is the rest of world including China.

 

Safe travels,

 

Steen

 

 

 

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