Lance Roberts

About the Author Lance Roberts

As an active portfolio manager for STA Wealth Management, Lance's primary role is to question the mainstream mantra. Rather than just regurgitating the news of the day, Lance looks at the “raw data” to bring a unique and “un-spun” perspective to the conversation. Lance's deep understanding of fundamental, technical and economic perspectives, combined with his unique focus, helps listeners understand how it impacts their family, their money and their life. "When a portfolio is fully invested, studying the reasons why the market will continue to rise is a bit pointless. As investors, we need to temper our bullish perspective with contradictory arguments to reduce 'confirmation bias.' If our job as investors is to 'buy low and sell high' we need analysis that helps us to identify those points." After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much "been there and done that" at one point or another. His common sense approach, clear explanations and “real world” experience has appealed to audiences for over a decade. Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to your money and life. He is also writes a daily blog which is read by thousands nationwide from individuals to professionals, and his opinions are frequently sought after by major media sources. Lance’s investment strategies and knowledge have been featured on CNBC, Fox Business News, Business News Network and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, Bloomberg, The New York Times, The Washington Post all the way to TheStreet.com. His writings and research have also been featured on several of the nation's biggest financial blog sites such as the Pragmatic Capitalist, Credit Writedowns, The Daily Beast, Zero Hedge and Seeking Alpha.

Fischer Keeps Rate Hike Door Open, But Shouldn’t

Over the weekend, economic luminaries (I use that term loosely) swarmed into Jackson Hole, Wyoming for the annual Kansas City Fed’s Economic “Let’s All Agree To Agree” Symposium. The message emanating from the meeting was exactly what was to be expected. Central Bankers from around the globe all concurred with the Fed’s assessment to increase rates despite a crashing Chinese economy, deflationary readings, a stronger dollar and elevated volatility and stress in the world’s financial markets.

Here is Fed Vice Chair Stanley Fischer:

“Given the apparent stability of inflation expectations, there is good reason to believe that inflation will move higher as the forces holding down inflation dissipate further. While some effects of the rise in the dollar may be spread over time, some of the effects on inflation are likely already starting to fade. The same is true for last year’s sharp fall in oil prices, though the further declines we have seen this summer have yet to fully show through to the consumer level. And slack in the labor market has continued to diminish, so the downward pressure on inflation from that channel should be diminishing as well.

With inflation low, we can probably remove accommodation at a gradual pace. Yet, because monetary policy influences real activity with a substantial lag, we should not wait until inflation is back to 2% to begin tightening.”

Here is the problem. While Mr. Fischer is correct that inflation is low, there is no sign that inflationary pressures will substantially rise, and stabilize, at 2% in the future. The two charts below show the real problem.

The first chart is the long-term deflationary problem facing the Fed using their preferred measure of inflation.

Inflation-GDP-Fed-083115

As shown the deflationary problem has existed since 1980 and continues today. While the fall in oil prices, and surging US Dollar, are certainly putting downward pressure on inflationary readings, that doesn’t really explain the long-term deflationary trend.

But this does.

GDP-Inflation-DebtGDP-083115

(Note: The current debt/GDP ratio is inaccurate due to the debt being capped at the current debt ceiling limit. The debt ceiling will rise in September which will send this ratio substantially higher.)

So, while the Fed keeps suggesting the economic growth and inflationary pressures are“just around the corner;” let’s revisit why the Federal Reserve raises interest rates in the first place.

The two primary mandates of the Fed are to maintain “full employment” and “price stability.” When an economy is growing strongly, employment becomes tight which leads to rising wage and price pressures. The Fed, in order to keep the economy from“overheating,” raises interest rates to SLOW economic growth to REDUCE burgeoning inflationary pressures.

The chart below is a simple look at the Effective Fed Funds Rate versus GDP. As you will see, the Fed has historically begun an interest-rate hiking campaign immediately following a strong rebound in economic growth.

GDP-FedRate-083115-2

The problem for the Fed is that they failed to hike rates during the economic rebound following the financial crisis and are now trapped on the wrong side of the economic cycle.

The Federal Reserve should have used the massive liquidity injections of QE1, QE2 and QE3 as support for the drag that would have been created by slowly hiking interest rates. The problem now is that after massively inflating stock market assets, there has been little economic growth to speak of while employment growth has primarily been a function of population growth and little more.

As I have written previously, there are three main drivers to inflationary pressures in the domestic economy: 1) Monetary Velocity, 2) Wage Growth, and; 3) Commodities.We can take these three components and construct and inflation index that reflects real activity in the domestic economy.

Inflation-Index-GDP-083115

As shown in the chart, there is currently little reason for the Fed to raise rates at this juncture.

Of course, the problem for the Federal Reserve is that the surge in deflationary pressures, combined with the negative impact of a strong dollar, is potentially pushing the economy towards the next recession. (We are on the long side of historical economic expansions so the possibility should not be ruled out.) I addressed the Fed’s dilemma recently stating:

The real concern for investors and individuals is the actual economy. There is clearly something amiss within the economic landscape, and the ongoing decline of inflationary pressures longer term is likely telling us just that. The big question for the Fed is how to get out of the potential trap they have gotten themselves into without cratering the economy, and the financial markets, in the process.

It is my expectation, unless these deflationary trends reverse course in very short order, that if the Fed raises rates it will invoke a fairly negative response from both the markets and economy. However, I also believe that the Fed understands that we are closer to the next economic recession than not.  For the Federal Reserve, the worst case scenario is being caught with rates at the “zero bound” when that occurs. For this reason, while raising rates will likely spark a potential recession and market correction, from the Fed’s perspective this might be the “lesser of two evils.”

The real risk for the Federal Reserve is keeping interest rates at zero and the deflationary feedback from the collapse in commodity prices, and the Chinese economy trips the U.S. into a recession. Given that “QE” programs have no real effect on boosting economic growth, the Fed would be left with virtually no “effective” monetary policy tools with which to stabilize the economy. For the Fed, this is the worse possible outcome.

Therefore, while the data clearly suggests the Fed should remain on hold in September, they are clearly keeping the “door open” to lifting interest rates anyway. With the financial markets beginning to lose stability, my expectation is that things are likely not to end as well as most mainstream analysts currently expect. Therefore, if the Fed is at all uncertain as to whether they should lift rates in September, the data clearly gives them an excuse not to.

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