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A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.

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Has the Fed's dual mandate been met?:

People say that we’re at “full-employment” and headline inflation is rising, yet the market is jumpy, the Fed is backtracking on rate hike cycle plans, and non-establishment political candidates are surging in the polls. 

Part of the reason may be that the so-called jobs recovery has been spearheaded by cheap labor, with job gains going disproportionately to the least educated — and lowest-paid — workers, many of whom have to work multiple jobs to make ends meet. At the same time, inflation expectations remain weak.

Market perceptions of the macro economy saw a major shift last month as it dawned on the consensus that Fed rate hike plans were on a collision course with the economic cycle:

Last summer on Bloomberg we discussed our view of no second half rebound, and that the Fed’s rate hike plans were on a collision course with the economic cycle. That realization only dawned on the consensus last month, triggering a major shift in market perceptions. 

As discussed on Bloomberg in December, the slowdown will continue, and that has not changed. There is no recession at hand, yet. But the big change since we spoke in early December is less about recession, and more about growing doubts surrounding what we call “three grand experiments” that are too big to fail.

These three grand experiments are now at risk of doing just that, as we had warned well before Japan went to negative interest rates:

In response to the Great Recession and Global Financial Crisis, the Fed embarked on years of ZIRP and QE, in an effort to push the economy to so-called “escape velocity,” following which they planned a rate hike cycle, that would get us back to “business as usual,” so that the U.S. wouldn’t “become Japan,” repeatedly revisiting ZIRP and QE. 

Japan, having “become Japan,” launched Abenomics three years ago in an all-out effort to get out of that trap. And China, which, following the Global Financial Crisis, launched an investment boom, the likes of which the world has never seen, has been attempting to pivot to a consumer-driven economy.   

Today it’s increasingly obvious that the Fed needs to backtrack bigtime, and there’s growing talk of a return to ZIRP and QE, and even negative rates. In effect, the Fed’s grand experiment is failing, so the U.S. is becoming Japan.  

Abenomics is clearly tottering, with GDP growing 0% on 2014, and 0.4% in 2015, and we now see Mr. Kuroda going to negative rates in desperation. 

And in China there’s been a major loss of confidence in the ability of their leaders, who were seen as infallible technocrats, to navigate a smooth transition to a consumer driven economy. This is why we wrote that “those who are thought to walk on water cannot afford to be seen to have feet of clay.”

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