Topsy-Turvy

Based on her speech this morning, Janet Yellen seems bound and determined to raise interest rates at the December meeting. Her interpretation of the labor market reports seems to led her to believe that all is well and growth is assured.

As I have said before, there are two prices that matter. One is energy and the other is labor. Energy is in glut, and prices have apparently resumed their decline after hovering in the mid 40s – low 50s basis oil. Labor prices are still being driven up by Obamacare’s soaring healthcare costs, even though real wages and disposable income are declining. However, yesterday’s ISM serves to confirm the wide variety of indicators that show manufacturing in rapid decline and world trade collapsing. It seems likely that labor demand and prices will follow suit with the usual several month lag.

It is interesting that even with a massive devaluation of the Euro (USD 1.06 as I write), inflation in the euro zone is non-existent. This is an indication of strong deflationary pressures, which are even more intense in the US as Yellen’s hawkishness serves only to strengthen the USD.

It is hard to imagine that Yellen’s move, assuming she does in fact carry through, will do other than further strengthen the dollar and increase deflationary pressures.

Long term Treasury bonds continue to be attractive, both fundamentally and technically. Zero hedge observes: “The last time the world was this short Treasuries, the 10Y yield collapsed from 3.94% to 2.39% in just 3 months.” When Japan raised rates under similar circumstances, JGBs soared and yields collapsed.

I think Ms Yellen’s action will be seen as a policy error. And if she changes her mind – again – it will be seen as a serious blow to her credibility. She is well known to be hyper-cautious, for example arriving three hours early for airline flights. This mindset is not serving her well. We’ll see.

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