It was only a month ago Fed President Dudley was lecturing us about the dangers of overly easy financial conditions and how inflation’s sanguine performance was “transitory.” And it wasn’t like he was alone. The Fed’s generally accepted second in command, Stanley Fischer, echoed similar comments.
Well, this morning about the most awkward economic news possible was released. CPI undershot, coming in at 1.6% instead of the expected 1.7%. Retail sales were abysmal, registering -0.2% instead of the forecasted 0.1% gain. And the University of Michigan sentiment numbers reflected a public who is becoming increasingly skeptical of the Fed’s rosy outlook. The actual index was 93.1 instead of the surveyed 95.0, but more importantly, expectations plummeted to 80.2 instead of 84.4.
This puts the Fed in a terrible place. It is obvious they have whiffed badly when it comes to meeting their inflation target. This morning Fed President Evans said “low U.S. inflation is a serious policy outcome miss.” Yeah, you don’t say? Well, what did you expect? Raising rates into an obvious economic slowdown will have that effect on inflation.
But you have to think Dudley and Fischer were aware of this possibility when they made their comments about financial conditions. So now the real question is how much they are prepared to follow up their words with deeds.
Make no mistake, the market will test them. Given that the market is now convinced the Fed is on the sidelines, the last remaining potential bearish catalyst has suddenly evaporated. With the weight of a heavily handed Fed lifted, stocks, and financial conditions in general, will explode higher.
And when they do, it will make Dudley, Fischer, and I also assume Yellen, extremely nervous. Stocks will almost dare the Fed to raise rates.
I can’t help but be reminded of the batter in the song Paradise by the Dashboard Light. You know the line – “Holy cow, stolen base! He’s taking a pretty big lead out there. Almost daring him to try and pick him off.”
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