Is Federal Reserve Policy Behind the Curve?

March 7, 2016

Mish's Daily

By Mish Schneider

The Dialectical Three- Raise, Keep, or Lower Rates?

Back on December 3^rd, 2015, I wrote a piece called, Ho Ho Ho- Santa Might Want Sugar With His Cup of Jo!

In that piece, I wrote that Commodities would be my main focus for the end of 2015 and the start of 2016. I gave 5 reasons why: one of those reasons was the “careful-what-you-wish-for” inflation target of 2%.

Since I had that sense back then, I looked up on the Board of Governors of the Federal Reserve System website, “Why does the Federal Reserve aim for 2% inflation over time?”

I found out that 2% is most consistent over the longer run with the Federal Reserve’s mandate for price stability and maximum employments. The FED believes that a higher inflation rate would impede the public’s ability to make longer-term financial decisions, and a lower inflation rate would suggest deflation and weak economic conditions.

In the “Goldilocks and the Three Bears” scenario, higher inflation rates mean the porridge is too hot. Lower inflation rates mean the porridge is too cold. And at a 2% inflation rate, the porridge is just right.

So then, why the “careful what you wish for?” What’s happening now with inflation data?

Has the Fed placed themselves between a rock and a hard place?

On March 7^th, two key Federal Reserve officials said they expect inflation to get closer to their target.

In an article by Lawrence Summers (Harvard Professor and treasury secretary form 1999-2001), posted March 6^th, he asks several questions: what if inflation expectations rose well above the 2% target with larger increases foreseen? What if commodity prices soar and the dollar declines? What if the GDP accelerates? What if there is no real effort to reduce budget deficits?

In essence, he is asking, “What if the FED’s policy is behind the curve?” If that is the case and the FED miscalculated inflation expectations, it could turn out very costly.

Over the last few weeks, gold, steel, copper, oil and certain soft commodities have awoken from their long sleep. The market has also rallied.

As a former trader on several NY Commodities Exchanges, I can tell you this: Commodities do not always behave themselves in an orderly fashion. Actually, statistics show that the worst inflation periods have occurred in a very short time. Furthermore, those stats do not reflect the age of social media and the blinding speed information now travels.

Summers says that, “the current low inflationary environment is as serious as during the so-called ‘Great Inflation’ of the 1970s, when inflation jumped, thanks in part to loose monetary policy in the US.”

Heck, I even said it on December 3^rd! Maybe even before that.

The next Fed meeting is scheduled for March 15^th. The rock and the hard place for our distinguished Fed Governors is whether they raise, keep the same, or lower rates? What are the foreseen and unforeseen impacts of each scenario?

For now, my Modern Family is still happy. Transportation and Retail remain in rally mode. Semi’s and Russell’s as well. Even Biotech played catch up to start the week. The only Family member contestant to lose the round in the “Price is Right” is KRE, Regional Banks.

Watch the continuing stampede in oil and the metals. Watch how the Family fares. Watch what the TLTs do, so far holding in a bullish phase. Watch the US dollar and how far it declines. Remember, this is the Year of the Fire Monkey. Unpredictable, clever and wild.

S&P 500 (SPY) Another low volume rally with 200-202 point of resistance and fairly significant too. 195 key support

Russell 2000 (IWM) Overbought conditions and big resistance at 109.50

Dow (DIA) 170-172 big resistance

Nasdaq (QQQ) FANG all red, with 103.50-104 key support.

XLF (Financials) 21.75 key support

KRE (Regional Banks) 37.00 support and must clear 38.79

SMH (Semiconductors) Confirmed the Accumulation Phase. Into some big resistance on the weekly charts

IYT (Transportation) 136.00 first point to hold. 140 a wall of resistance

IBB (Biotechnology) A close over 271.77 better otherwise, has to hold 260

XRT (Retail) 45.61 the 200 DMA

IYR (Real Estate) I still cannot believe my eyes that this has gone straight up.

GLD (Gold Trust) Inside day. With the shortage of physical gold a breakout of the pattern to upside is in the cards