Watch the Fed’s New Guard, Not the Old

Watch the Fed’s New Guard, Not the Old

Expert consensus was almost unanimous that the Fed sent a hawkish message after its September meeting. A December rate hike was ‘still on the table’.

The view was expressed in all of the major news outlets.

Markets got the message. The dollar rallied, the euro declined, gold traded down, and interest rates ticked up. That’s exactly what you would expect.

There was only one thing wrong with this story, as I explained at the time: Everything.

And Friday’s exceptionally weak core inflation data only drives home the point.

It practically guarantees the Fed will not raise rates in December.

The US economy is not strong and the Fed may not raise rates again until well into 2018 — if then.

How can so much time, effort and talent be devoted to such a simple task and still get the wrong result? How could they get it so wrong?

The answer is that the so-called experts are using the wrong model of Fed behaviour. As I’ve said many times, if you have the wrong model, you will get the wrong result every time.

Its major shortcoming is that it pays attention to the Fed projections of growth and interest rates. Pay no attention to these.

However, there’s a much more important Fed story that hasn’t gotten much media attention. This story could have a dramatic impact on interest rates going forward.

I’m talking about a changing of the guard that’s taking place at the Fed. I’ve mentioned it before, but I want to reinforce the point…


The Federal Reserve’s Board of Governors is made up of seven appointees.

That means that they can make a majority decision with four votes. The real power within the Fed is found on this seven-member Board of Governors.

Here’s the remarkable part:

As of last month, four of the seven Fed board seats are now vacant.

Trump inherited two board vacancies from Obama. Then in April, Federal Reserve Governor Daniel Tarullo resigned.

Then, Fed Vice Chairman Stanley Fischer suddenly and unexpectedly resigned. His resignation marked the fourth vacancy.

That means Donald Trump will be able to shape the Fed’s majority in a remarkable fashion.

Incredibly, he now has the opportunity to appoint a higher percentage of the Board of Governors of the Federal Reserve system at one time than any president since Woodrow Wilson.

It’s amazing, but it’s true.

I told my readers months ago that ‘Trump owns the Fed’. That reality is playing out even faster than I expected then.

And this is not counting Janet Yellen, whose term expires at the end of January.

I fully expect that a man called Kevin Warsh is the likely next chair of the Fed.

This is a complete changing of the guard. The old guard, Yellen and Fischer, are leaving.

Board of Governors member Lael Brainard has admitted publicly that the Fed models are broken and they have no idea what they are doing…

I mention this because on 5 September, Brainard delivered one of the most significant Fed speeches ever.

She more or less admitted the Fed has no idea how inflation works.

Brainard pointed out that the Fed began its current monetary policy tightening cycle in the belief that tight labour markets implied inflation was coming…with a lag.

Instead, the opposite happened.

The Fed’s favourite measure of inflation plunged from 1.9% to 1.3% between January and August 2017, even as job creation continued and the unemployment rate fell.

In other words, the relationship between tight labour markets and inflation turned out to be the exact opposite of what the Fed believed. Its models are in ruins.

Of course, this is what I’ve been telling my readers to expect all year.

The Fed was tightening into weakness, not strength, and would soon have to flip back to ease in order to avoid an outright US recession. And ease is exactly what Brainard called for in her speech.

Inflation is needed for the US to have any hope of getting its massive debt problem under control. This means government theft from savers and negative real rates.

What does all this mean for markets?

You should expect lower real rates, slower balance sheet normalisation, and higher inflation than markets are now pricing. This will not happen all at once, but in stages over the next year.

The biggest winner will be gold. The time to enter your gold position, if you don’t already have one, is now. Go here to find out more on the Australian angle of my strategy going forward.


Jim Rickards
Contributing Editor, The Daily Reckoning Australia