When Forward Guidance Fails

When Forward Guidance Fails

While The White House crows of the falling unemployment rate (which everyone now knows is entirely useless as an indicator of anything), the rapid-drop in this indicator is a major headache for the Fed. While forward-guidance is crucial in replacing the “common knowledge” that the Fed remains easier-for-longer as bond-buying is tapered, despite it’s dismissal by vice-chair Stan Fischer and BoE’s Carney (and even an almost admission of its weakness by Bernanke), Yellen faces a market that is betting massively (actually in record size) that short-term rates will rise and Fed heads like Lacker shift to “more qualitative ways” of maintaining the punchbowl.

The unemployment rate is meaningless (as we have shown numerous times but most recently here)…

So what happens when one renormalizes the unemployment rate calculation and uses a 30 year average labor force participation rate as a constant instead of a variable to be plugged by the BLS to goalseek a desired result? This happens:

What the chart above shows is that the “real” unemployment rate in October 2009 was 11.2%. Where is it now? 11.1%.

And there is your “Obama Recovery”, when stripped of all the fancy veneer and TOTUSed propaganda, right there.

Vice-Fed Chair Stanley Fischer is a skeptic of forward-guidance:

In contrast to his statements on QE, he has recently expressed a more skeptical view of forward guidance. Specifically, he noted in September that

[Simply put, Since July, the market has been betting in increasing size – now at record-size- that short-term rates will rise]

The interest-rate derivative market is still very short,”, Jim Lee, head of U.S. derivative strategy at Royal Bank of Scotland Group Plc’s RBS Capital Markets in Stamford,Connecticut, said yesterday.

So the path of most pain ahead is lower rates. These positions are likely to be squeezed out if rates fall further.”

A nascent unraveling of record derivative bets on higher interest rates may accelerate as turmoil in the world’s emerging markets and a tepid U.S. economic recovery sends bonds higher, according to RBS Capital.

So, The Fed is desparate to keep the world believing that they will be easier-for-longer but have lost any anchor of credibility for how to guide investors as to what that means without just an open-ended “we’ll do it forever” meme. The market is betting the Fed will be unable to achieve lower for longer and is the most one-sided that rates will rise ever in history… which is why, if the EM crisis deepens or the slowing real economy glimpses its own shadow from a farce of weather-excused data, the max pain trade is a huge squeeze lower in rates.

As Bloomberg previously noted,

While there will probably be no major policy shifts in the January statement, investors will scrutinize the minutes when they are released on Feb. 20 to see if potential policy changes such as reducing the employment threshold to 6.5 percent or imposing an explicit inflation floor around 1.5 percent were debated.

Given the probable direction of the unemployment rate amid a structurally damaged labor market and disinflation, the Fed faces a dilemma in that the status quo is untenable and may soon be challenged by traders and investors eager to move back toward interest rate and policy normalization.

But the Bottom-line is that forward-guidance can only work if it is consistent and believable. The Fed has already begun jawboning to the extent that its previous forward guidance will change its structure and the most recent jobless data only reinforces the fallacy of unemployment rate thresholds. When the truth is the Fed ‘has’ to taper as the costs outweigh the benefits, and the replacement for QE is lower-rates-for-longer; a failed forward-guidance meme merely reinforces in the minds of investors the Japanification of the USA is complete.

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