Most Federal Reserve meetings are not surprises.
We know and have known for months that the Fed is going to raise interest rates today and will likely do so again in September.
There is talk that the Fed may do another rate hike in December or it may not.
That question has been the focus of the financial news this week.
At the last meeting, the Federal Reserve was predicting two more rate hikes, but there is talk that they should up that to three more (meaning an additional hike in December), because of higher energy prices and low unemployment numbers.
However, Fed Fund futures this morning have only a 38% chance of a rate hike in December.
If the Fed sticks with one more hike instead of two that announcement could easily rally gold and silver for the rest of this month.
But there is a Fed surprise that is going to come one day that will spark the next real big run in the metals.
This could be the day.
If not now then it will come in September most likely.
First of all the Fed is running into a problem. The yield curve is flattening and a few more rates hikes will invert the curve, which turns it into a recession signal which would destroy the credibility of the Federal Reserve Chairman Jerome Powell.
When the yield curve began to flatten in 2006 Ben Bernanke claimed that we were heading for a “soft landing” and you could ignore it.
We all know what happened next.
Powell does not want to invert the yield curve and he knew this situation when he was interviewed for the job by Donald Trump.
Right now the 1-year Treasury bond yield is 2.31% and the 10-year is at 2.96%.
So three rate hikes from here risk inverting the curve with the Fed Funds rate sitting at 1.70% right now.
But unemployment numbers are low and traditional economic theory based on the “Philips curve” that the Fed has used for decades says that low unemployment will mean rising wages which will spark inflation.
So there is pressure on Powell to hike fast to stop theoretical coming inflation. What Powell wants to do is raise rates as much as he can without inverting yields. That means pausing after one or two more hikes.
But Powell must give a reason to pause!
And it has to be a good reason, meaning it must be bullish for the economy and stock market.
Remember Powell is not an economist, but graduated from Georgetown with a law degree.
He spent most of his life being the top bank lobbyist in DC where he worked on K street to advocate for budget deficits and raising the debt ceiling for the Bipartisan Policy Center, which Wall Street banks make a lot of money from by buying and selling bonds.
Remember when the debt ceiling was the issue back in 2010 and 2011?
Well, Powell was the key guy pushing Congress to raise the debt ceiling and arguing debts are fine to do it!
He knows how to make political policy arguments that please his masters.
So Powell put out stories back in October in the press before his interview with Trump in which he said he doubted the Philips curve and would look for new theories to explain why wages can remain low even with low unemployment to use to argue that Fed rate hikes can at some point be put on pause.
The reality is that this Milton Friedman theory does not seem to be working now even though it is Fed orthodoxy.
There is a simple explanation for that, but yesterday the Wall Street Journal had an interesting story that revealed what Powell has been spending his day doing as Fed chairman:
“As a Fed governor, Mr. Powell sometimes chafed at the central bank’s academic bureaucracy. It generates world-class analysis but sometimes grinds such a fine point that weeks could go by before he would receive an elaborate presentation delivering the answer to a question.”
“As chairman, Mr. Powell prefers more informal, direct and immediate interaction with the Fed’s staff of Ph.D. economists. He frequently arrives for work at 6:15 a.m. and peppers them with questions via email at all hours, according to people familiar with the matter.”
“If hiring and workforce participation trends since January continue, unemployment would reach as low as 3.3% by December, way below Fed officials’ estimates of the level that is sustainable over the long run.”
“Among the questions preoccupying Mr. Powell: Could a tighter labor market bring in people not already in the job market and raise workforce participation rates? If that happens, the economy will be in a position to draw on those unused resources and keep growing without overheating. That would allow the Fed to raise rates more slowly than it otherwise would.”
In other words Powell doesn’t have a theory of why the Philips Curve doesn’t work anymore, but is spending all hours of every day pressuring people at the Fed to come up with reasons why it doesn’t, because he doesn’t want to pick up the pace of Fed rate hikes, but do the opposite.
He will find a way to make that argument when the time is right, because that is what he has done all his life.
And working on this argument has been Powell’s big preoccupation since he became Chairman.
This whole WSJ story is worth reading here:
It is also worth noting that the biggest public critic of the Philips Curve over the years has of course been Larry Kudlow who is now Donald Trump’s top economics advisor.
So you can know that it is only a matter of time that Powell presents arguments for why the Philips Curve is no longer valid to use to justify pausing interest rate hikes.
That will be the dovish signal that will fuel the next giant run in gold. Silver may go up even before that happens.
Politically now probably isn’t the moment for Powell to drop this bombshell, because not everyone on the Fed is on board with him yet.
But more of them will be once the yield curve gets even closer to getting inverted.
Now there is a simple reason why the low unemployment numbers aren’t creating the inflation that the Philips Curve predicts that is pretty obvious even though it is a reason that Powell can’t use.
And that’s is that the numbers aren’t real!
Or at best they are meaningless.
Take a look at this table which comes from the United States Labor Department.
This is government data you can see for yourself here.
What it shows is a total unemployment rate of just under 8% – that factors the real number of people without a job that could be working instead of the low number used for TV that eliminates people who have not looked for a job for 15 months or longer to create a super low number by having a smaller labor force in the calculation than there really is.
But government experts need real figures.
And so there is the U-6 rate for them and the U-3 “official unemployment rate” for the TV audience.
U-6 shows there is no super low tight labor market like people are talking about so we should not be surprised that the Philips Curve doesn’t seem to be working when the headline unemployment rate is so low.
One of the theories that Powell is having his Fed economists explore is an idea that the labor force is actually going to grow in the coming years by bringing people into it who have not been looking for a job in a long time.
Tomorrow I will show you what they are looking at and why the facts are actually shocking.
There is no real economic boom.
Oh, the stock market has risen for years thanks to low rates and buybacks fueled with tax cuts, but wages are not going up and the real number of unemployed is really not falling fast enough as you would see in a real boom at all. You need bigger GDP growth than 3% for that.
Since 2009 the US economy has been in a weak recovery and today we are in the last few innings of that recovery, which is ending like the last two did and that is with the formation of a speculative bubble that will lead to disaster.
In 1999 that bubble was in tech stocks.
In 1999 that bubble was in tech stocks.
In 2006 it was in real estate and mortgage securities.
Today it is in the bond market, which grew to become the biggest bubble in human history in 2016 and is now slowly starting to unwind.