The FOMC members at the June meeting were concerned about the unexpectedly weak May payrolls and the impact of the pending British European Union referendum on the U.S. economy even though at the time polls indicated that the vote would fail. They decided to postpone a rate hike until the economic and political pictures were clearer.
"Most participants judged that, in the absence of significant economic or financial shocks, raising the target range for the federal funds rate would be appropriate if incoming information confirmed that economic growth had picked up, that job gains were continuing...and that inflation was likely to rise above 2 percent..."
By observing caution the Fed has set itself an impossible standard.
There are five criteria in the above statement: economic and financial shocks; rising U.S. economic growth; labor market gains and rising inflation. What are the chances that all five will be met for a period of several months, long enough to let the Fed sneak in another 0.25 percent increase? What are the chances that just the first four, leaving out inflation which the Fed has been predicting will return to 2 percent for more than three years, will coincide?
In the wake of the British vote we have seen the sterling drop to 30 year lows, the yen strengthen to over 100 against the dollar, derailing what is left of Prime Minister Shinzo Abe's economic revival plans and the yield on the U.S. 10-year Treasury fall to its lowest in history.
In European equities the financial sector has been hammered, Italian banks are desperate for new capital and Deutsche Bank, the largest German bank, holds a derivative portfolio larger than the entire German economy.
The new EU banking regulations, the product of much acrimonious dispute, stipulate than any government bank recapitalization must use bail-in funds from depositors, a requirement that the Germans insist be followed. In response Italian Prime Minister Matteo Renzi said the true European "derivative problem" is Deutsche Bank.
In China the government is rapidly devaluing the yuan to the level where it held the currency for two years during and after the financial crisis. Around the globe almost $10 trillion of sovereign debt returns a negative yield and the amount is growing month by month.
Any one of these problems in a healthy global economy would be enough to give the cautious bureaucrats in the Eccles Building pause. The combination guarantees that the projections of the Fed 'dot plot' are an exercise in wishes very unlikely to be fulfilled.
Chief Market Strategist