By The Time The Fed Hits Its Goals, The Markets Will Be Crashing

Authored by Graham Summers via Gains, Pains, & Capital,

The Powell Fed has set one goal and one goal only for its policy…

Hitting the “neutral rate of interest.”

The neutral rate of interest is when the Fed has rates equal to the pace of inflation. While this is technicallywhat the Fed is SUPPOSEDto be doing, NO Fed (or any other Central Bank for that matter) has done it in over 30 years: the Greenspan, Bernanke, and Yellen Feds were all notorious for running “accommodative” policy in which rates were kept well BELOW the rate of inflation.

Indeed, if you had to summate Fed policy from 1987 to 2018, the best word would be “accommodative.” It is not coincidental that this time period coincided with serial bubbles in the financial markets. This was done intentionally by Alan Greenspan, Ben Bernanke, and Janet Yellen.

Not Jerome Powell.  During his July Q&A session with Congress in July, Fed Chair Powell emphasized that the most important focus for the Fed under his leaderhsip would be “a neutral rate of interest.”

In answering a question [concerning the yield curve flattening] from Senator Pat Toomey of Pennsylvania, Powell said that, in his view, “What really matters is what the neutral rate of interest is.” And perhaps longer-term Treasury yields send a message about that rate.

Source: Bloomberg

I initially thought this was Powell playing to Congress (for 30+ years Fed Chairs have simply told Congress what it wanted to hear during their testimony). However, since that time, the Powell Fed has made it 100% clear that it did in fact WANT neutral rates.

Last month, Dallas Fed President Robert Kaplan outlined this in no uncertain terms.

The neutral rate of interest is the federal funds rate at which monetary policy is neither accommodative nor restrictive. It is a theoretical concept, meaning that it can’t be directly observed—it must be inferred from market and other economic data. Economists’ views on this rate are necessarily estimates and inherently uncertain. However, while theoretical, estimates of the neutral rate are critical to assessing and making decisions regarding the stance of monetary policy.

My own view, informed by the work of my colleagues Evan Koenig at the Dallas Fed as well as John Williams of the New York Fed and Thomas Laubach at the Federal Reserve Board, is that the longer-run neutral real rate of interest is in a broad range around 0.50 to 0.75 percent, or a nominal rate of roughly 2.50 to 2.75 percent.

With the current fed funds rate at 1.75 to 2 percent, it would take approximately three or four more federal funds rate increases of a quarter of a percent to get into the range of this estimated neutral level.

At this stage, I believe the Federal Reserve should be gradually raising the fed funds rate until we reach this neutral level. At that point, I would be inclined to step back and assess the outlook for the economy and look at a range of other factors—including the levels and shape of the Treasury yield curve—before deciding what further actions, if any, might be appropriate.

Source: Dallas Fed

The key items in the above quote are the fact that a Fed President is OPENLY calling for neutral rates (all but unheard of). Moreover, Kaplan is basing his view on the work of NY Fed President John Williams. Williams is Vice-Chair for the Fed (Powell’s right hand man). He, like Powell, is also a voting member of the Fed Board.

Put a different way… the above quote is effectively Fed leadership broadcasting to the world that its current line of thinking is that the Fed will be hiking rates until it reaches a neutral rate.

Doing this is going to create a SERIOUS issue for the financial markets. As we noted earlier this week, already globally numerous markets ranging from China to Germany have entered corrections, if not outright bear markets as a result of the Fed’s hawkishness.

Eventually this mess is going to spill into the US markets. When it does, the bursting of the Everything Bubble will have officially hit US shores.