“Why is the Fed so desperate to raise rates and tighten financial conditions? Why has the Fed shifted from a dovish to a hawkish bias?”
That is the question on every trader’s, analyst’s and economist’s mind in the past month. Is it because the Fed is suddenly worried it has inflated another massive equity bubble (major banks now openly warn their clients the market is in frothy territory, if not inside a bubble), or is the Fed just worried that it will fall too far behind the curve and be unable to regain control of the economy once inflation spikes, without creating a recession (in what will soon be the second longest, if weakest, economic expansion of all time).
This is also what BofA’s chief economist Ethan Harris tried to answer over the weekend, when he recalled that while from 2013 to 2016 the Fed seemed to have a “dovish bias” signaling a slow exit from super easy monetary policy, but pausing at any sign of trouble, this year the Fed appears to have shifted to a “hawkish bias:” signaling a slow exit, but only pausing if the outlook changes significantly. He says that this was most evident when the Fed hiked rates and signaled balance shrinkage at its June meeting despite weak growth and inflation data.
The second reason for the Fed’s hawkish turn is that it is probably encouraged by how easily the markets have absorbed its forecasts. Since the start of the year the Fed has hiked more than expected and has accelerated its balance sheet shrinkage plans and yet, as Goldman has repeatedly noted and all other banks have promptly followed, stocks have rallied while bond yields have been little changed on net. If a steady exit is causing no apparent pain, why not continue? (for one answer, read the latest note from Deutsche Bank on Conundrum 2.0)
This post was published at Zero Hedge on Jul 10, 2017.