The Fed Is Still Hell-Bent on Melting the Market

Evidence is mounting, but it's sticking with its phony numbers

Core personal consumption expenditures (PCE) finally hitting 2% is more proof that common measures of consumption goods inflation follow interest rates higher.

As the U.S. Federal Reserve continues to rubber-stamp the tightening money markets by announcing increases in the Fed Funds target rate, the consumer price index (CPI) and PCE will continue to ratchet higher.

The Wall Street Journal looked at it this way: "A key measure of inflation accelerated last month to the fastest annual clip since 2012, as robust spending by consumers and businesses steadily pushed up prices for goods and services across the economy."

News Corp.'s Dow Jones sister ship, the more liberal free daily, Marketwatch, put it this way: "The strong economy has pushed a key inflation barometer to a six-year high and all but assured that U.S. interest rates will soon rise."

The media in general took the attitude of, "Wow, look at that. The Fed hit its inflation target, and it will keep raising interest rates."

Good grief. This isn't news. We've known all along that inflation has always been above 2% - if measured honestly.

Here's another thing we already know: As the Fed raises interest rates, increased borrowing, spending, and inflation follows. This pattern continues until very late in the cycle, when policy tightening becomes truly punitive.

Now, in the past, the tightening of the supply of money has tagged along with the rise in interest rates.

But there's a difference this time around. The policy tightening - the actual draining of reserves from the system - has preceded and driven the rise in interest rates.

The distinction is "live or die" important for the stock market...

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The Market's Running Out of "Demand Fuel"

In the past, the Fed gradually tightened the supply of money simultaneously with its increases in interest rates. Stock prices rose along with that, until rates became positive versus speculative returns.

This time, the Fed is removing money from the system, draining the tank of the fuel for demand. Rates have merely followed that draining activity.

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Speculative mania has returned to the stock market, and traders have borrowed their way to pushing prices higher.

Of course, they've been helped by pension fund panic buying, where managers are seeking to take advantage of a tax break that expires next month.

Also helping is the one-time repatriation of corporate cash from overseas due to the tax amnesty.

What's so bad about that? Well, these demand drivers are really just one-shot deals, like firecrackers.

Once they're done, they're done.

At that point, the only demand driver left will be margin borrowing. As the leverage grows, so will the risk of a "disorderly adjustment," a.k.a. a crash.

Now that you know what's at stake, back to the data.

The Fed Can't Find Inflation? I've Got It Right Here...

Core PCE, the Fed's favorite measure of "inflation" is the most suppressed of all the popular inflation measures.

Not surprisingly, it is the last to reach the goal line of the Fed's 2% target rate. But on a year-to-year basis, core CPI has been there since March, 2018.

The Fed

Both measures are heavily statistically "massaged" to report numbers lower than what most of us real people actually experience in the marketplace.

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Both substitute the prices of cheaper goods for more expensive ones. The PCE measure does it more aggressively than CPI.

Neither captures actual housing inflation. The Bureau of Labor Statistics (BLS) uses a measure called Owner's Equivalent Rent (OER) as a substitute for actual house prices. It accounts for roughly a third of core CPI.

Using 2016 as the base year, the basis for the OER measure has risen by 7.4%, or an average of 3.7% per year.

Using the very conservative Federal Housing Finance Agency (FHFA) measure of house sale prices, home prices have inflated by 13%, or 6.5% per year.

That's a gap of 2.8% per year between the CPI housing component and actual housing inflation as conservatively measured.

Melting the market

At a third of total core CPI, that shaves about 0.9% off the headline number.

The bottom line: If housing inflation were properly measured, CPI would today be closer to 3.3% than 2.4%.

In other words, it would have never been below the Fed's stated goal since it announced the 2% target in 2012.

If that weren't enough, a pure, unmanipulated measure of the wholesale price of finished consumer goods, which ignores housing altogether, has never been materially below 2% except for a few months in 2013.

This measure is now rising at a 2.8% annual clip.

So, the reality is not that "the Fed is just now reaching its target." The reality is, as correctly measured, consumer inflation is well above 3% and headed higher.

The Central Bank's Stupidity Is Going to Cost Investors

The Fed is behind the curve. It is far behind the curve, and it will not only continue to tighten, as the fake official inflation numbers start to catch up with the reality, but the Fed may even be forced to tighten more than currently expected.

That means that the sanguine attitude of bond traders will be severely challenged, to put it mildly, in the months ahead, as the official inflation numbers continue to ratchet higher.

Any way you slice it, the days of a sub-3% 10-year yield are numbered.

Meanwhile, the money markets harbor no illusions. They can't. There's just not enough money around to absorb the deluge of Treasury issuance resulting from the massive and growing Federal budget deficit.

At the same time, the Fed is extinguishing the money needed to absorb the blizzard of paper.


When money tightens, stock investors are always the last to get the news and the last to understand the implications.

This rally to new all-time highs in the stock market has flown in the face of tightening liquidity; this rally is on borrowed time.

Just how much time is left?

Well, that's a matter for technical analysis I'm working on right now.

My Sure Money Investor readers following along with my recommendations are in SPDR S&P 500 Trust ETF (NYSEArca: SPY) calls set up to take advantage of the present extended mania.

That same analysis will tell us when to get into SPY puts, to capitalize on the severe decline ahead.

You can click right here to get every single one of my Sure Money Investor updates, including when to get out of the calls and into the puts. I'll send three updates each week - all absolutely free of charge for Money Morning Members.

Your Financial Future Is at Stake (Are You Prepared?)

If you're like most Americans, you've felt a sense of market turmoil ahead. We could be in for another white-knuckle ride... a "Great Reckoning," if you will.

The vast majority of folks don't see this coming, and those few who do are not preparing properly... nor profitably.

So ask yourself, right now: Are you where you want to be financially?

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About the Author

Financial Analyst, 50-year charting expert, finance + real estate pro, and market analyst; published and edited the Wall Street Examiner since 2000.

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