The FOMC: What Next?

In another week the FOMC will have its final meeting of 2018 and its last with the current mix of policy makers. Already, the discussion has turned to what the Committee will do at that and subsequent meetings: Will it proceed with further 25bp increases in the target range for the federal funds rate, or will it pause?

Federal Reserve - FOMC

Markets appear to have priced in another rate increase in December, at least as signaled by what has happened to the short end of the Treasury curve, shown in the chart below.


 

Chairman Powell afforded this view credibility in a speech he gave on November 28 in New York.[1] Although the purpose of the speech was to highlight the release of the Fed’s first-ever financial stability report, he did touch on monetary policy. After noting the delicate balance between moving policy rates too fast or too slow to achieve the Fed’s dual mandate and the need to consider information contained in incoming data, he stated that, as far as current policy is concerned, “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy….” What Powell is clearly saying is that he would be comfortable with at least one more rate increase, and this sets the stage for the FOMC’s next move in December.

There are two important reasons why the FOMC will move at its next meeting. First, it has provided justification of where rates should be to be “neutral”- that is, neither too tight nor too loose with regards to slowing down or speeding up growth. Second, that justification blunts any perception that the FOMC may be bowing to political pressure from the White House when it comes to setting rates. By saying it is “almost there” and stating that further moves are data-dependent, the FOMC is setting the stage for a possible pause. And the rationale for such a pause will be contained in the Summary of Economic Projections, if the Committee does indeed decide that it has achieved a neutral policy stance.  Clearly, world growth is slowing and should the slowing continue that may be sufficient to justify a pause by the Committee.

The minutes of the November FOMC meeting, released November 29, reinforce the “almost there” view articulated by Chairman Powell in his speech. The minutes reveal some concern on the part of FOMC participants about the risks to inflation posed by uncertainty concerning the fiscal situation and trade policies. The Committee laid those concerns aside, however, in commenting on the path for policy, and there was agreement that “another increase in the target range for the federal funds rate was likely to be warranted fairly soon if incoming information on labor market and inflation was in line with or stronger than their current expectations.” However, some expressed uncertainty over the timing of further increases, while at least two participants expressed the view that the neutral policy stance had been achieved. The bottom line is that the minutes, combined with Chairman Powell’s “almost there” hint in his NY speech, perfectly position the FOMC for another rate increase at its December meeting, while preserving flexibility to pause at future meetings and putting some distance between the FOMC and the White House.

The minutes are interesting for another reason as well, because they indicate the nature of the current state of the discussions about how future policy might be conducted once the Fed has normalized its balance sheet. That decision is shown to hinge critically on whether the FOMC decides to return to the pre-crisis regime of a balance sheet determined primarily by currency demand and a low level of excess reserves or favors instead a large balance sheet with a large volume of excess reserves. The former would imply policy exercised by small changes in the volume of excess reserves achieved through manipulation of the federal funds rate in the overnight market. The latter would imply continuing the reverse repo approach and dealing with a larger number of potential non-bank counterparties, such as money market mutual funds. It is clear from the discussion that no decision on these alternatives has been made, and the decision process is complicated by changes in how financial markets have functioned in the wake of the financial crisis. The clear message in the minutes is that this discussion is “to be continued.”

Robert Eisenbeis, PhD.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] Chairman Jerome H. Powell, “The Federal Reserve’s Framework for Monitoring Financial Stability,” The Economic Club of New York, New York, November 28, 2018.

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Deficit, Fed, Post-Midterms

“In 2016, President Trump pledged to eliminate the national debt ‘over a period of eight years’ (“In a revealing interview, Trump predicts a ‘massive recession’ but intends to eliminate the national debt in 8 years,” https://www.washingtonpost.com/politics/in-turmoil-or-triumph-donald-trump-stands-alone/2016/04/02/8c0619b6-f8d6-11e5-a3ce-f06b5ba21f33_story.html).

Market Commentary - Cumberland Advisors - Deficit, Fed, Post-Midterms

He then signed a $1.5T tax cut bill and a two-year spending deal that could push annual deficits above $2.1T, according to the CRFB (“Budget Deal Could Lead to $2 Trillion Deficits,” http://www.crfb.org/press-releases/budget-deal-could-lead-2-trillion-deficits).

“For the rest of his term, Trump plans to add $8.282T more to the federal debt, which will push the debt levels to about $30T in total (“New White House Report Shows Deficit Projections Have Doubled,” http://www.crfb.org/press-releases/new-white-house-report-shows-deficit-projections-have-doubled). That represents a 41% increase from the $20.245T debt under the Obama administration. Trump will add as much debt in four years during a time of economic prosperity as Obama did in eight years while fighting a recession. That will make Trump the second biggest contributor to debt in history.” (“Obama: US spends more on military than next 8 nations combined,” https://www.politifact.com/truth-o-meter/statements/2016/jan/13/barack-obama/obama-us-spends-more-military-next-8-nations-combi/). Source: https://seekingalpha.com/article/4204900-drowning-debt-road-30-trillion.

Some of my fishing buddies like to write alarmist newsletters and wring their hands over debt. One of those newsletters hit my inbox on Saturday morning, November 3. That one forecast dire future outcomes.

My fishing buddy may be right someday, but I will bet my fly rod against his bait-casting device that, for the next few years, the increased debt financing of the United States will not be a problem for markets. That will remain the case as long as the US dollar is the unchallenged world reserve currency, as it has been for decades.

When you survey the world and look at other countries’ economic systems and current situations, the US emerges as the best or, if you are a hand-wringing detractor, the least troubled. It is true that the expansion of debt slows down productivity growth. Debt service, even at low interest rates, is an allocation of a cash flow away from growth investment in capital deepening. There, the newsletter writer was correct. But by itself, rising debt issuance will not trigger a debt-service crisis for the US.

Comparisons with Italy or Greece are dramatic. But they are neither helpful nor accurate. And they are not true of our political system versus European systems.

It is true that the US is likely to run deficits exceeding $1 trillion annually. It is also true that President Trump said one thing about the deficit and did the opposite. It is true that the cyclically adjusted federal deficit is probably a lot larger under Trump than it was under Obama. Of course, Trump will never admit such a thing. And expect no such admission from a Republican Senate, nor from a Pelosi-led House.

And it is true that we are approaching a debt-ceiling fight, which will break out shortly after the 116th Congress is sworn in on January 3. Note that the new Congress will commence this activity amidst the ugliness of a politically divided government. The coming debt-limit fight will occur in the shadow of the recent nasty midterms and as the 2020 presidential election cycle fires up in earnest. No serious deficit-reduction measures are expected to advance in the forthcoming lame duck session. If anything, the deficit will be increased by the outgoing 115th Congress if they have a way todo it

Estimates are that the US Treasury will end 2018 with a cash balance of $410 billion (source: US Treasury and Barclays). That balance will be reduced to about $200 billion by March 1, 2019. Note that a reduction of the Treasury cash balance acts as an increase in bank reserves since it is an actual transfer of the cash from the Treasury to the banking system. That’s right: the higher the Treasury cash balance at the Federal Reserve, the lower the excess reserves in the banking system and vice versa. Remember: The Fed acts as the banker for the Treasury.

The deficit is being financed mostly by the rising issuance of Treasury bills, so a small shock is coming to the short-term funding markets in the next few months. We will see this in the spreads among the various measures in the short-term, riskless end of the yield curve. We may also see the Fed have to make another adjustment in the spread between the upper end of the fed funds limit and IOER (interest on excess reserves) as rates press the upper bounds of the Fed’s policy target. Note that for many technical reasons the Fed’s task is becoming more and more difficult as the Fed shrinks its balance sheet.

There is a debate among observers about the Fed’s policy direction and an additional debate about the Fed’s trying to do two things at once. It is hard enough for the Fed to get one thing “right.” Yet this Fed persists in trying to shrink its balance sheet and raise the target policy rate at the same time. We think by March or April or May the Fed will have reached a point where the short-term funding markets will no longer have the luxury of those large balances of excess reserves. The timing is uncertain here, and the list of factors that could change things stretches longer than a page. That said, the short-term funding markets are already showing increasing pressures, albeit small ones. I agree with Zoltan Pozsar, at Credit Suisse, that the additional pressures will soon be apparent.

When we see these pressures surface, there will be many who point to the rising federal deficit as the cause. We can almost hear the chorus now. But that will not be the reason, in our view. The reason will be that the Fed is doing two things at once, with impacts that are likely to collide. Therefore the Fed will add to the confusion about causality. As Ben Bernanke rightly pointed out, the Fed will eventually have to increase the size of its balance sheet. Any shrinkage now is temporary and counterproductive for the longer term.

Will there be a policy change? Will the Fed stop shrinking its balance sheet soon? I would like to say yes, but I doubt that it will. The Fed seems hell-bent on maintaining its schedule unless some shock occurs. Why we might need the shock as a wake-up call is beyond me. Will a new Congress ask that question?

President Trump hasn’t helped matters by bashing the central bank, though the decisions of the Fed are not likely to be influenced by any bashing. Most of the central bankers that I personally know take their roles very seriously and see themselves as avoiding politics and focusing on policy outcomes. But they are also doing two things at once without really explaining how the two policies intersect and interact. The Fed hasn’t explained, for instance, the market impact of raising rates while forcing duration into the market. But that is exactly what they are doing, and that is why they are risking a shock.

It would help if the Fed could offer markets clarity on the pathway to normalcy in the US. My expectation is that we won’t get it. And the task of interpreting the Fed will be increasingly difficult. Key indicators to watch are the spreads among the short-term funding instruments in markets where credit risk is not the issue. In our firm we review them daily. We look for a shift of a few basis points as a sign of pressure. And we look for nuances in Fed policy changes.

For the average investor these are difficult tasks. They require a lot of data surveillance. One has to track spreads between T-bills and repo and SOFR and fed funds and IOER. For those who wish to dig deeper into this subject, there are discussions and serous research papers at the websites of the Fed Board of Governors and the twelve reserve banks. The NY Fed is the center of this daily activity.

In the management of bond and ETF portfolios at Cumberland, we rarely make changes based on these minor basis-point shifts in funding markets, but we do watch them carefully. Our clients’ portfolios are separately managed accounts structured with investment objectives that are not adversely affected by these very small shifts. The opposite is true for very large institutional portfolios. Still, for us the daily watchful waiting remains critical, since it provides early-warning signs of trouble.

Right now there is little pressure evident in the high-credit-quality funding markets. There is excess liquidity, though it is being gradually withdrawn. As of now, the federal deficit is easy to finance, and there is no rollover risk (that is, no risk in refinancing short-term debt).

We don’t expect such risk to surface in the US in our post-midterms period. My friend who likened the US to Greece and Italy is in error. They have rollover risk; we don’t.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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The November FOMC and the Election

The November FOMC meeting is scheduled for November 7 & 8, one day after the November 6 midterm election.

Federal Reserve - FOMC

We are not looking, then, at the possibility of any further FOMC action on interest rates that might influence the election one way or another, but what about after the election? Is the FOMC likely to increase rates another 25 basis points at this next meeting? Let us look at what information the FOMC will have next week.

The bulk of the economic data that has arrived since the last FOMC meeting is not only very positive but also consistent with the FOMC’s projections. On the inflation front, both of the FOMC’s preferred measures of inflation – headline inflation and the core Personal Consumption Expenditure Index (PCE) – actually declined in September, as the attached chart shows; and inflation now sits right on its target of 2%. More importantly, there are few signs of its accelerating. Energy prices have started to slow, and the rate of growth in housing prices has dropped below 6% for the first time in a year. Both of these components’ prices typically start accelerating as inflation pressures increase.

 

We see in the next chart that economic growth has shown unusual strength in the last two quarters, despite the negative impacts of the changing US tariff policies that have resulted in exports subtracting from real growth. Indeed, the last two quarters’ growth of 4.2% and 3.5% are the fastest the economy has grown since the third quarter of 2014. GDP also continue to outpace the Beige Book characterizations of growth. In the most recent Beige Book, four districts said that growth was modest (slightly below 2%); six said growth was moderate (slightly more than 2%); one said growth had increased slightly; and only one (Dallas) described growth as robust.”

Job-market data show a tight labor market, with more vacancies than unemployed people and an unemployment rate of 3.7%. Job growth, too, has been positive, with an average 208K jobs per month being added this year, as shown in the next chart. Today’s 250k jobs numbers continue the solid trend shown in the above chart. While these numbers look good, based upon recent history since the end of the financial crisis, they are more consistent with an economy growing at the rate of 2.2–2.4% and an economy growing at 3.5%–4.2%. Interestingly, if the economy today were creating jobs at the same rate it did between 1983 and 2006, the monthly jobs numbers would be twice what they are presently.

So with the economy on track with the FOMC’s projections and with no indications that inflation is accelerating, the FOMC can afford to stick with its projection for just one more rate hike this year. There is no planned press conference for the November meeting, nor will there be formal revisions to the FOMC’s Summary of Economic Projections. Given these facts, the chances are slim to none that there will be a rate hike next week.

Robert Eisenbeis, PH.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


Source: https://fred.stlouisfed.org/


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Markets to Head Higher After Rocky Period (Radio)

David Kotok, Chief Investment Officer/Co-Founder, Cumberland Advisors, joined Bryan Curtis and Rishaad Salamat on Daybreak Asia. He says the fundamental issue for markets is still trade, he goes on to say whatever the outcome of the midterm elections, we will then have clarity for the next two years.

“Just lifting the uncertainty, I believe, will give the market room to recover. So, in our shop, we still see new highs by the end of the decade. We don’t see a recession. We do see a slowdown because of the trade war. We’re already seeing it. We do see a little more inflation for the same reason. Although a strong dollar helps dampen that as long as the currency stays that way. And we think markets are going to head higher after we get through this rocky period.”
-David Kotok

Running time 06:06

LISTEN HERE: https://www.bloomberg.com/news/audio/2018-10-31/markets-to-head-higher-after-rocky-period-radio

NOTE: Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.


If you like podcasts, check out this one from 2015 featuring David Kotok talking about his background and Camp Kotok with Barry Ritholtz. They also talk about the history of Cumberland Advisors since its founding, and delve into fundamental principles of investing and valuation.


Links here
https://itunes.apple.com/us/podcast/masters-in-business/id730188152?mt=2

And here
http://www.bloomberg.com/podcasts/masters-in-business/




Doc Holliday, Jay Powell, Donald Trump & The Piano

“Ready, Fire, Aim”?

In Understanding and Managing Public Organizations, Hal Rainey makes the point that “the intangible issues of culture, values, human relations – matters that many managers regard as fuzzy and unmanageable – can and must be skillfully managed.” The contrary approach, which is favored by many companies and government agencies, can be summarized as “ready, fire, aim.” (Understanding and Managing Public Organizations, https://books.google.com/books?isbn=0787980005)

 

Market Commentary - Cumberland Advisors - Please do not shoot the pianist. He is doing his best

Rainey’s insight will prove relevant as we consider this week’s stock market carnage.

Politico offered this explanation for the carnage:

“WHY MARKETS TANKED AND WHAT’S NEXT — The real surprise is it took this long. Wall Street has been shrugging off a rising 10-year yield, fear over the trade war with China and uncertainty surrounding the midterm election for way too long. The S&P 500 did not record a single move up or down of 1 percent by the closing bell in the third quarter. That hasn’t happened since 1963, according to LPL Financial.

“That kind of calm is what’s abnormal, not the 3 percent decline in the Dow and S&P on Wednesday and the 4 percent decline in the Nasdaq. President Trump blamed the drop in part on the Fed, saying the central bank had ‘gone crazy.’ He also referred to a ‘a correction we’ve been waiting for,’ which is a much better explanation.”
(Politico, 10/11/2018, 8 AM EDT: https://www.politico.com/newsletters/morning-money/2018/10/11/why-markets-tanked-and-whats-next-370573)

Now, in order to assist the fact checkers, here is the full Trump quote:

“The Fed is making a mistake. They’re so tight. I think the Fed has gone crazy. So you could say that, well, that’s a lot of safety actually, and it is a lot of safety, and it gives you a lot of margin, but I think the Fed has gone crazy.”
(Politico, 10/11/2018, 8 AM EDT: https://www.politico.com/newsletters/morning-money/2018/10/11/why-markets-tanked-and-whats-next-370573)

Here’s our take.

The (in)famous Doc Holliday (https://www.historynet.com/spitting-lead-in-leadville-doc-hollidays-last-stand.htm) occasionally played the piano at the legendary Silver Dollar Saloon in Leadville, Colorado. When Oscar Wilde appeared at the Tabor Opera House across the street, he would cross the street to the saloon for a drink or two after his lectures. Wilde noted that there was a sign over the piano that read: “Please do not shoot the pianist. He is doing his best.” (Source: a personal visit to the legendary Silver Dollar Saloon)

The sign over the piano could apply to today’s Federal Reserve. The Fed now has over a 100-year history. It is doing the best it can. Let’s not shoot it.

At the recent NABE conference, Fed Chairman Powell said,

“This historically rare pairing of steady, low inflation and very low unemployment is testament to the fact that we remain in extraordinary times. Our ongoing policy of gradual interest rate normalization reflects our efforts to balance the inevitable risks that come with extraordinary times, so as to extend the current expansion, while maintaining maximum employment and low and stable inflation.”

He added that “The economy is seeing a “remarkably positive outlook … and a modest steepening of the Phillips curve would be unlikely to cause a significant rise in inflation or demand a disruptive policy tightening. Once again the key is anchored expectations.” He welcomed the recent rise in wages and stated, “Higher wages alone need not be inflationary.” We thank Mike Englund and his team at Action Economics (www.actioneconomics.com) for capturing Powell’s quote with precision.

There is a lot of Fed-related jawboning about the recent employment report. Many folks argue that it was distorted by hurricane effects, so we need another month to gain clarity. With Hurricane Michael now added to the natural disaster list, we may hear the same chorus when the October data is compiled and released.

Meanwhile, the inflation outlook is coupled with the question of whether or not wages are trending upward and accelerating. And the negative economic effects of the Trump-Navarro trade war are only beginning to show up in the data. On a positive note the new NAFTA agreement with Canada and Mexico has reduced anxiety in markets and seems to have stabilized a trending deterioration in sentiment. That improvement (the situation is now less worse than expected) may offset the impact of the US-China lack of progress. Without a directional policy change, the China-US imbroglio could prove very serious. The fears that we articulated in our Thucydides Trap pamphlet are sadly being realized. (The pamphlet is available here in PDF form: “Lessons from Thucydides,” https://www.cumber.com/pdf/Lessons-from-Thucydides.pdf.)

Of course, for the investor the issue is, what does all this mean for future Fed policy and interest rates?

The Treasury yield curve has abruptly steepened. We expected that to happen, given the one-time influence of a special tax provision that expired in mid-September. See “Why the Yield Curve Is Flat and Why It May Steepen,” https://www.cumber.com/why-the-yield-curve-is-flat-why-it-may-steepen/. And we looked to the high-grade muni curve for some guidance. See “The Tale of Two Ratios: Shorter and Longer,” https://www.cumber.com/the-tale-of-two-ratios-shorter-and-longer/. The pricing of munis is set mostly by high-income American investors. The muni curve was steep and continues to be so. Treasury yields result from investments by both Americans and foreigners – a blend of influences. Thus the muni curve may be a better source of high-grade forecasting power. We think it deserves some respect.

So what about wages and inflation?

We updated our series of Beveridge curves. Nearly all of them point to a wage acceleration coming. (We will send any reader the 8-chart series if you provide us with a full snail-mail address.) That series depicts specific unemployment rates crossed with other indicators like job openings or quits. It tracks the last expansion period, the Great Recession and financial crisis, and the recovery since. When viewed together, the curves make a compelling case for an acceleration of the upward trend in wages and for rising inflation. Beveridge curves tell you Fed Chairman Jay Powell may soon see his “historically rare pairing” appear more normal.

My friend Michael Drury at McVean Trading had this comment following on his observation that “Wages have grown at a 3.2% apace over the past 11 months.” He expects 3.2% to continue and notes that “3.2% means wages are compensating workers for 2% inflation and 1.2% productivity growth.” Meanwhile, other economists argue about that productivity growth and ask, “Where’s the beef?”

My friend and fishing buddy Danny Blanchflower is a labor economist and ardent student of Keynes and Beveridge. Danny is a Dartmouth professor of economics, Bloomberg contributor, former Bank of England board member, and serious academic researcher. He and I have discussed the concept of NAIRU, the non-accelerating inflation rate of unemployment – in other words, the level of unemployment below which inflation rises. (For more on NAIRU see https://en.wikipedia.org/wiki/NAIRU.)

NAIRU is not observable, so it has to be estimated. Danny notes that there were periods in history when the estimate for NAIRU was as low as an unemployment rate of 1 to 2%. He cites Keynes and Beveridge for that history. He also notes how central bankers routinely miss on their estimates of NAIRU. That means they are playing the saloon piano when it isn’t tuned.

Danny uses something he calls the U-7, which quite simply is the U-6 unemployment rate minus the U-5 unemployment rate. He is trying to find a marginal shift that signals the turning point where NAIRU is reached and the upward pressure from accelerating wages influences inflation. If we use his back-of-the-envelope approach (he has serious research on this), we can estimate that NAIRU may be as low as a 3% unemployment rate, given the present structure of the US labor force. (For a full description of the various US unemployment rates and the methods of data collection, see “How the Government Measures Unemployment,” https://www.bls.gov/cps/cps_htgm.htm.) Furthermore, as the national statistics gravitate toward this 3% NAIRU estimate, regional and state statistics are tending to confirm the trend. Great work on the state data is performed by Philippa Dunne and Doug Henwood. I suggest serious readers check out the October 4th edition of TLR on the Economy. If you are interested, send me an email with your contact information, and I will ask Philippa to send you a copy of that research.

We have taken Danny’s U-7 concept and developed some measures and estimates of the impact of the changes in the U-7 on things like the Consumer Price Index, average hourly wages, and JOLTS (the job openings portion of the labor data). What we are seeing in every series is a trend toward rising wages and rising inflation. It is hard to discern the exact month of acceleration in these series, but there seems to be some consistency. We will send any reader who gives us a snail-mail address a set of our U-7 charts. Researchers now have a road map if they want to develop their own statistics.

Let’s sum this up after we thank those journalists and friends and colleagues cited here. Please remember that anyone who is writing and publishing publicly is under repeated attack these days, as the Constitution’s First Amendment protections seem threatened by political forces unlike those we have seen in American history in recent decades.

We think the president’s attack on the Fed was wrong. It hurts his political party. It hurts the country. And it helped tank the markets. The Trump-Navarro US-China trade war is worsening, and markets don’t like it. Markets now fear that Trump has undone the beneficial effects of his repatriation policy, tax cuts, and deregulation initiative. What started out on a positive path is now a war between the two largest economies of the world. That war now seems to be intensifying. Remember: In a shooting war the guns are pointed at each other; in a trade war the guns are pointed inward. Nobody wins.

The warning on the saloon piano was apt. Don’t shoot the player who is doing his best. (And especially don’t try to shoot the player if it is Doc Holliday.)

Mr. President. You will do what you want. That is continually made very clear by your behavior. The country will determine who is loco. And history will report the results.

We are allocated toward domestic weights in our US ETF managed accounts. We have a cash reserve. We are in a correction.

Positions in portfolios can change at any time.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




The Fed Isn’t Crazy, Trump’s Trade War Is: David Kotok (Radio)

David Kotok, Chairman & Chief Investment Officer at Cumberland Advisors, on the market selloff, Trump blaming the Fed, and his current economic outlook. Hosted by Pimm Fox and Lisa Abramowicz.

Running time 06:48

LISTEN HERE: https://www.bloomberg.com/news/audio/2018-10-11/the-fed-isn-t-crazy-trump-s-trade-war-is-david-kotok-radio

NOTE: Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.


If you like podcasts, check out this one from 2015 featuring David Kotok talking about his background and Camp Kotok with Barry Ritholtz. They also talk about the history of Cumberland Advisors since its founding, and delve into fundamental principles of investing and valuation.


Links here
https://itunes.apple.com/us/podcast/masters-in-business/id730188152?mt=2

And here
http://www.bloomberg.com/podcasts/masters-in-business/




FOMC Closes Out Q3 2018

As Treasury markets had correctly predicted, the FOMC raised its target range for federal funds by 25 basis points to 2.0%–2.25% at its meeting on Wednesday, Sept. 26.

Federal Reserve - FOMC

Perhaps more importantly, it also deleted the observation that policy remains accommodative, though Chairman Powell went out of his way in his opening remarks to point out that its removal should not be interpreted as a signal about the future path of rates. Rather, it was simply a reflection of where the Committee saw policy. This so-called clarification, however, didn’t square entirely with his observation that financial conditions remained “accommodative.”

Since the meeting was also one in which the Committee revised its Summary of Economic Projections (SEP), it is worth noting that there were really only three changes or additions worth commenting on. First, both the median GDP growth for 2018 and its central tendency were revised up slightly, which Chairman Powell said reflected the strength of incoming data and robust consumer and business confidence. Second, forecasts for 2021 were added, and GDP for each year after 2018 was projected to be lower than the preceding year’s, with the figure for 2021 showing growth of only 1.8%, equal to that forecast for the longer run. At the same time, there were no significant changes in the forecasts for unemployment or inflation. When asked about that, Chairman Powell simply stated that the inflation dynamics now appear to be different from those of the past, implying that the Phillips curve is essentially flat. Finally, even by the end of 2021, the median federal funds rate is expected to be still almost a half percentage point higher than the longer-run rate.

Looking beyond September to the end of the year and possible rate moves in 2019 and beyond, the dot chart suggests that 12 of the 16 participants think there will be one more hike in 2018. Given that by December the Committee will have an observation on Q3 GDP and a new set of SEP forecasts available, the likelihood is that the rate move will occur at that meeting. Moreover, with regard to the moves that have occurred this tightening cycle, there has been no instance when an increase was approved at a meeting when no press conference was scheduled and no SEP forecasts were available. Note that all meetings in 2019 will be followed by press conferences.

Interestingly, for 2019 the median-rate data suggest three moves that year and two more in 2020, stopping at 3.25% to 3.5%. This policy path would put the funds rate above the Committee’s equilibrium longer-run rate, and that fact triggered questions directed at Chairman Powell as to whether there is likely to be a policy overshoot. His response essentially suggested that people should not take those longer-run rate projections as being firm, since knowing when to stop will be data-dependent. He did observe that the gradual pace of the Committee’s policy moves enables it to monitor how the economy is responding and to minimize the risks of a policy mistake that might trigger a recession.

This observation by Chairman Powell raised the question in the press conference as to what could impact the policy path. Tariffs, deficits, oil shocks, and greater-than-expected growth were all key factors Chairman Powell identified that could impact both the pace of policy and the decision to pause. All in all, Chairman Powell continued his strong performance, exhibiting not only depth and breadth of knowledge but also patience in responding to questions. Given the information flow and the short-term forecast for another rate move in 2018, it would not be surprising to see the term structure move up rather abruptly, by about another 25 basis points, in advance of the December FOMC meeting, as it did leading into this September meeting.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


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Fed Expected to Say Policy Will Be ‘Data Dependent,’ Cumberland’s Eisenbeis Says

Robert Eisenbeis, vice chairman of Cumberland Advisors and a former Atlanta Federal Reserve research director, talks about the central bank’s policy.

Fed Expected to Say Policy Will Be 'Data Dependent,' Cumberland's Eisenbeis Says

He speaks with Shery Ahn and Haidi Stroud-Watts on “Bloomberg Daybreak: Asia.” (Source: Bloomberg)


 

Direct link to video: https://www.bloomberg.com/news/videos/2018-09-26/fed-expected-to-say-policy-will-be-data-dependent-cumberland-s-eisenbeis-says-video


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Fed staff research anchors subtle shift that could lead rates higher

Reuters Wednesday August 29, 2018 18:42
Excerpt of: Fed staff research anchors subtle shift that could lead rates higher
by Howard Schneider

WASHINGTON  – The U.S. Federal Reserve should be ready to lift interest rates for a longer period or even more quickly than currently expected to insure against a jump in inflation in a U.S. economy operating in the vicinity of full employment.

That is the message that has been percolating up from senior central bank staff economists to policymakers including Fed Chair Jerome Powell in research that has helped inform a subtle shift in how Powell plans to steer policy amid growing uncertainty about concepts such as full employment and the neutral level of interest rates.

Powell on Friday signaled he was wary of how accurately the Fed can estimate some of the variables that are important to the U.S. central bank’s models of the economy, including the level of full employment and the “neutral” rate of interest, and was thus hesitant to be guided strictly by how they interact.

“A skeptic would say that the models aren’t working – and this is what Powell is indirectly saying,” Robert Eisenbeis, chief monetary economist with Cumberland Advisors, wrote this week. “His answer is to fall back on risk management,” or weighing the cost of a mistake in either direction and choosing the less costly option.

Read the full article at Reuters.com




It’s in the Stars

As is the custom for Fed chairs, Chairman Powell provided the kickoff address to the Kansas City Fed’s annual Jackson Hole symposium, broadly attended by many of the world’s central bankers.

For those who are unfamiliar with the conference, the papers presented are generally conceptual economic policy documents with a distinctly longer-run, bigger-picture focus rather than a discussion and assessment of currently policy. In that vein, Chairman Powell provided an interesting and thoughtful discussion of the problems that he and the Fed face in setting policy going forward.

Some commentators on the speech focused on missing elements such as Powell’s failure to mention trade and tariff issues or the changing role that international economic integration has on the policy environment of changing policy regimes. These factors are clearly important but weren’t central to Chairman Powell’s thought piece, which really focused on the more abstract conceptual framework upon which the Fed’s current policy is depends.

Before discussing that framework however, Powell first provided a brief, but obligatory, overview of the current economic situation. It proved to be just a restatement of what was noted in the FOMC’s July/August policy statement and subsequent minutes. He noted that growth is strengthening, unemployment is at a 30-year low, and inflation is at the 2% objective. There was nothing new or noteworthy here.

Then Chairman Powell then turned to the more interesting part of the speech – interesting in part because it appears that he is revealing his own discomfort with the current policy framework. He first poses two disparate questions that observers and critics might ask any FOMC participant today, questions that encapsulate the policy conundrum the FOMC now faces. The questions are paraphrased below:

(1) With unemployment so low, why isn’t the FOMC tightening policy faster to head off potential overheating and a rise in inflation?

(2) Or, with inflation so low, why is the Fed tightening, thereby risking higher unemployment and a recession?

The first question is rooted in a Phillips-curve view of the world in which tight labor markets inevitably lead to inflation, while the second question ignores evidence on the lags of monetary policy and reflects the view that inflation isn’t a problem until it is. Powell has structured these questions as a policy problem of balancing two risks: the risk of being behind the curve versus the risk of being too aggressive.

Against this set of policy questions, Powell then goes on in a clear but oblique way to discuss how economists are currently framing policy in terms of (a) the desired rate of inflation, and (b) the two abstract concepts of the natural rate of unemployment and the natural rate of interest. Economists have dubbed the natural rate of unemployment u-star (u*) and defined it as the rate of unemployment that would prevail in an economy growing at its potential, where people would be unemployed only due to friction and structural reasons – that is, unemployed due to skill mismatches, mobility problems, or lack of information. The natural rate of real interest or r-star (r*) is the real rate that would exist in an economy operating at full employment and growing at its long-run potential.

Powell then proposes the simple, effective analogy that policy is like trying to navigate by the stars (u* and r*), where the course of policy is dictated by inferior instruments (ie. models) in which action depends upon the direction and magnitude of the deviations of actual unemployment from u* and of the estimated real rate of interest from r*. But the problem is that neither of the two stars nor the potential rate of growth of the economy are known with any degree of certainty.[1] Thus it is hard for policy makers to know exactly where the economy currently stands in terms of these conceptual anchors. The problem is doubly difficult because the anchors also have moved over time.[2] It is also important to note at this point in the discussion that Powell omits any mention of the policy tools that the FOMC has in its tool kit or how they are linked to changes in the deviations of the actual economy from u*, r*, or potential growth.

So, if policy makers don’t know exactly where the economy lies relative to these key variables, what are they to do? Put another way, a skeptic would say that the models aren’t working – and this is what Powell is indirectly saying. So, in the face of this conundrum, what does a practical policy maker like Chairman Powell do? His answer is to fall back on risk management, which says go slowly, be observant, and be prepared to act. In the current economic environment of steady growth, low inflation, and low unemployment, this means the FOMC should continue with gradual tightening, since policy is still accommodative, but be prepared to change if inflation and, importantly, inflation expectations change.

Overall, this was a speech that was clear, honest, and pragmatic. Some might have wanted more, especially since stargazing isn’t working too well, but Powell has laid out clearly what the conceptual problems are and how the Fed is proceeding.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] Indeed, the error bands around estimates of these parameters are quite wide.
[2] As an aside, this is part of the reason that President Bullard of the St Louis Fed has argued that regime shifts make policy formulation and forecasting very difficult.


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