The Boock Report

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Dudley is reminding us again of what’s most likely to come

Quantitative Tightening

If you had doubts about whether the Fed would begin quantitative tightening in September because of the recent inflation figures, NY Fed President Bill Dudley, a key member of the troika, is telling you AGAIN that it’s coming. He said “I think we’re still on the same trajectory we’ve been on for several years. Above trend growth, gradually tightening labor market, inflation (somewhat below our objective) but we do expect as the labor market continues to tighten, to see firmer wage gains and that will ultimately filter into inflation moving up towards our 2% objective.” On the tightening of the labor market he added, “a pretty broad range of evidence suggests the labor market is quite a bit tighter than it’s been in many years.”

The Fed is comfortable with beginning QT because “It’s been I think generally well received, and fully anticipated. People expect it to take place.” This gets to my point I’ve made that if I’m going to punch you in the face but gave you a month’s notice and hugged you after, would it hurt any less. The Fed seems to think so and the market right now seems to thinks so too.

To all those who yell about how the Fed won’t hike again because of the recent low inflation stats, Dudley said this as reason to continue to “gradually remove monetary policy accommodation:

“1) monetary policy is still accommodative, so the level of short term rates is pretty low, 2)and this is probably even more important, financial conditions have been easing rather than tightening. So despite the fact that we’ve raised short term interest rates, financial conditions are easier today than they were a year ago.” The underline is mine. “The stock market’s up, credit spreads have narrowed, the dollar has weakened, and those have more than offset the effects of somewhat higher short term rates and the very modest increases that we’ve seen in longer term yields.”

Thus, markets have rallied themselves RIGHT INTO ANOTHER RATE HIKE assuming current conditions come December. Herein lies the Fed’s conundrum, if markets sell off after QT, the market would sell itself AWAY FROM ANOTHER RATE HIKE. Pick your poison. Notice the market feedback loop the Fed is now on with the Goldman Sachs Financial Conditions index now a key indicator of theirs?

In response, the 2 yr yield went to the high of the day as did the 10 yr yield. The dollar is also at the high of the day vs the euro while stocks are unperturbed.