Lack of Fed consensus on future intentions a little unsettling

Minutes show chaotic disagreement on how to tighten

The big story of the week is the odd combination of saber-rattling by the Fed but falling long-term interest rates, mortgages just above 4 percent.

First a rundown on other matters high in the news but ho-hummed in markets.

Difference of opinion image via Shutterstock.
Difference of opinion image via Shutterstock.

Iraq has gone off-screen entirely, oil prices right back where they were before the place fractured. The dreaded Sunni-Shia new-age Thirty Years' War may ensue, but so long as oil flows and violence is confined there ... all for the entertainment of the locals.

There was a time when new violence Israel versus Hamas (or whomever) would upset markets. No longer. The world has tried many times and many ways to engineer peace of some kind, but the parties involved are determined to keep at it. All yours.

Ukraine is partly mysterious. Diplomatic exchanges between Merkel and Czar Vladimir are exceptionally private, and it is not clear why he has backed away from military action, and from his "rebels," but it is obvious that even in ethnically Russian parts of Ukraine there is no great popular desire to join Vladimir's economic paradise.

Markets did flinch at an oops-a-daisy by a bank in Portugal, but remembered the European Central Bank is not going to let any bank go dominoes.

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But in the background were new reports of shrinking industrial production in Italy, France and Germany, the fundamental euro disaster beyond the power of the ECB to fix. Italian and Spanish 10-year bonds each pay 2.78 percent, and German 1.21 percent. Falling eurozone bond yields two years ago were good news, but this far is a depression/deflation trade.

Even if the U.S. economy faints between now and October, we are done with QE."

On Wednesday the Fed released minutes of its June 17-18 meeting, three important pages out of three dozen.

First, the Fed preannounced the end to QE3 in October. From buying $85 billion per month in Treasurys and MBS, the Fed will go to zero. No maybe. Even if the U.S. economy faints between now and then, we are done with QE, the Fed's balance sheet over $4 trillion. If we refaint, the Fed will try something else.

Panic followed the QE taper announcement last year. If the Fed stops buying bonds, who will take its place? The market has been helped by a dramatically lower federal deficit and collapsed MBS issuance.

However, on Wednesday the Treasury auctioned $21 billion in new 10-year T-notes. Who would buy, after another 200,000-plus job gain announced just the week before?

Buyers elbowed to get the new notes, pushing the yield down from 2.65 percent the week before to 2.52 percent, and holding a lower trading range, which began in May.

Important Fed page No. 2: the obligatory scattergram showing each Fed governor's future intentions for the Fed funds rate (the overnight cost of money) and the intentions of regional Fed presidents in a plot of 16 anonymous dots.

Winston Churchill said he was relieved to escape his post as Chancellor of the Exchequer because he "couldn't keep track of all the damned little dots." He was referring to decimals. The Fed's damned little dots drive everyone nuts because no one, certainly including the Fed, knows how reliable these intentions may be, but there they are.

dam_dots

Source: federalreserve.gov

The damned dots are clustered at a 1 percent Fed funds rate by the end of 2015. Three of the dots say no increase at all. One, obviously pea-brained Esther George of the Kansas City Fed, wants to go to 3 percent. Another four are posted between 2.25 percent and 1.25 percent. Consensus like that is soooo reassuring.

Intention to tighten leads to important page No. 3: how to tighten in the presence of $4 trillion in excess bank reserves (the flip side of the Fed's assets). I have no doubt that the Fed can tighten, but the "how" discussion inside the Fed was chaotic disagreement.

Most important of all, why and when to raise its rate ... silence. A desire to "normalize," but that's all. Whatever it might mean.

The 2.9 percent contraction in first-quarter gross domestic product was overstated, consumer spending plodding along at 1 percent. The second quarter was supposed to rebound strongly and did not, maybe 2.6 percent GDP, consumer spending to maybe 1.5 percent. If these numbers continue, the Fed will be tightening very little in 2015. If at all.

10_yr_T_Barnes_7_11_14

10-year T-note, six months back. Sensitive to the Fed, but even more so to prospects for the economy and inflation.

2_yr_T_Barnes_7_11_14

The 2-year T-note is most predictive of the Fed. Short-term money predicts short-term. A little up-movement, but no respect for the Fed's scattergram.

oil_barnes_7_11_14

West Texas Intermediate oil, Iraq spike gone.

Lou Barnes is a mortgage broker based in Boulder, Colorado. He can be reached at lbarnes@pmglending.com.


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