Put the Fed in a Washing Machine

Stop me if you’ve heard this one before: A Fed official walks into a bar and says the economy is improving and rate hikes are appropriate. The patrons order another round to celebrate. Then disappointing data comes out, the high fives stop, and the Fed official ducks out the back…only to come back the next day saying the same thing. Anyone who pays even the smallest attention to the financial media has experienced versions of this joke dozens of times. Yet every time the gag gets underway, we raise our glasses and expect the punch line to be different. But it never is. Last week was just the latest re-telling.

For nearly a month the Fed’s bullish statements stoked optimism on the economy and raised expectations, based particularly on the most recent FOMC minutes, for a summer rate hike. But these hopes were dashed by the May non-farm payroll report, which reported the creation of only 38,000 jobs in May, the worst monthly performance in six years, based on data from the Bureau of Labor Statistics (BLS). The number missed Wall Street’s estimate by a staggering 120,000 jobs. If not for the 37,000 downward revision reported for April (160,000 jobs down to 123,000), May could have shown a contraction. This would have constituted a major black eye to the Obama Administration’s favorite talking point that its policies have led to 75 months of continuous job gains. (6/3/16, Democratic Policy & Communications Center).economy. Normally it does so when the economy is accelerating. Some identify this delay as the Fed’s only policy error. But had it moved earlier, the recession would have simply arrived that much sooner. The Fed’s actual policy error was thinking it could build a “recovery” on the twin supports of zero percent interest rates and QE, and then remove those props without toppling the “recovery.”

But despite all this, there are those who still believe that the Fed will deliver two more rate hikes this year. Given the anemic growth over the past two quarters, the recent plunges in both the manufacturing and service sectors, average monthly non-farm payroll gains of only 116,000 over the past three months (most low-wage, and part-time) and the stakes contained in the election that is just six months away, such a conclusion is hard to reach. Instead, I expect we will get the same bar gag we have been getting for the past year. Many of those who now concede that a June hike is off the table still believe July to be a possibility. I believe the Fed will go along with that hype until it can no longer get away with it…then it will start bluffing about September, or perhaps December.

The Fed has to keep talking about rate hikes so it can pretend that its policies actually worked. But the truth is that the Fed policies have not only failed, they have made the problems they were trying to solve worse, and raising interest rates will prove it. So the Fed resorts to talking about rate hikes, to maintain the pretense that its policies worked, without actually raising them and proving the reverse. This can only continue as long as the markets let the Fed get away with it or until the numbers get so bad that the Fed has to admit that we have returned to recession. That is the point where the Fed’s real problems begin.

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