These Numbers Could Push the Fed to Do Something Stupid

The Daily Treasury Statement data for the end of month in August showed some improvement in total tax collections, including a slight uptick in withholding taxes and an even bigger increase in excise taxes.

The numbers suggest that an early summer slowdown has ended. After the expected downward revisions in June and July jobs data, the August uptick in jobs was not a fluke. And the excise tax data suggests strong retail sales.

So, not an altogether bad summer - if you happen to be a politician or government taxman. But what about for investors?

Well surprise, surprise, surprise! Good news is bad news, which is what we've been talking about here all along.

Good economic news, as presaged by the uptick in tax receipts, will encourage the Fed to keep tightening.

And tighten it shall, in two ways: Most importantly (and most destructively) it will drain more money from the banking system. Secondarily, it will continue to rubber-stamp tightening money markets by raising the Fed funds rate.

And that, as I have been shaking my fist at the sky about for months, is really bearish.

The stuff has not hit the fan yet, but it is coming...

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Coming Up: More Senseless Capital Destruction

All the good-bad news about jobs and soaring GDP was the impetus for some outright bad-bad news.

On Monday, Boston Fed Head and former staunch policy dove Eric "The Red" Rosengren suggested that the central may need to do even more slashing, burning, and pillaging of the money in the banking system.

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OK, so he didn't use exactly those words. But here's what he did say in interviews with Reuters (and later on CNBC) where he would be sure that professional investors would see or at least hear about it loud and clear:

"If things work out well for the economy, and that's what I expect and hope, then we'll be in a situation where we need to have somewhat restrictive policy over time."

Now I don't know about you, but I don't exactly consider rising economic numbers sparked by massive, unprecedented deficit spending, courtesy of tax cuts and surging military outlays, to be "working out well for the economy."

But what is important here is that the Fed sees it that way, except for one little problem: Rising inflation.

Rosengren told Reuters, "This is not hair on fire. There is upward pressure on inflation, and given that we are already at 2%, labor markets are already tight... that is going to be a situation where we start persistently having inflation above what our target is. There is an argument to normalize policy and probably be mildly restrictive."

Just as we already knew, the Fed is not only behind the curve, it is pushing the curve, because rising rates send a signal to businesspeople and consumers to expect higher rates - and therefore higher prices.

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That causes them to accelerate spending and investment, which stimulates that which they're trying to reign in - higher inflation.

This also causes the economy to grow faster, into a final blowoff, as consumers, businesspeople, and - lest we forget - investors rush to go all-in.

The Fed

The problem with such behavior only becomes apparent after everyone is all-in. That leaves a demand vacuum going forward, and ultimately financial and economic collapse. In the meantime, the economy accelerates, albeit toward a cliff's edge.

So the Fed is just waking up to the fact that it is behind the curve.

Normally, I'm all for enlightenment, but this is the central bank we're talking about here. I've long maintained that, should the Fed actually realize it's behind the curve, it could become even more aggressive in tightening.

Now we have confirmation of that.

Fed heads are floating trial balloons. The history of the past dozen years tells us that when Fed heads start talking about something, it's all but a done deal. It should take two, maybe three more Federal Open Market Committee meetings before they make it official with a policy announcement.

It could take the form of more aggressive balance sheet reductions, but more likely, they'll start to raise rates in half-point rather than quarter-point increments.

In fact, the money markets will force them to. Treasury bill rates are soaring relentlessly. The Fed has no choice but to tag along raising the Fed Funds rate. Otherwise it will appear to have lost control.

Soaring T-bill rates are a sign of the market running short of cash in the face of a constant onslaught of massive bill supply, while the Fed steadily removes money from the system. Remember, it is now extinguishing $40 billion per month. Next month, that goes to $50 billion.

The drains are scheduled to remain at that level until bank reserves on the Fed's balance sheet reach a "normalized" position.

Without going into the particulars, I have estimated that at $50 billion per month, the Fed's balance sheet will finally be good n' normalized in May 2020.

Rosengren thinks the Fed should make hay while the sun shines. He doesn't think the Fed has enough room from here to loosen enough to be really stimulatory when the next recession comes along.

In other words, the beatings will continue until we've crushed the economy, and then we'll be able to drop rates and loosen policy enough to restart it. Rosengren wrote in a Boston Fed release that "More attention should be given to establishing appropriate policy buffers to mitigate future shocks."

Here's How to Play It While the Fed Makes Hay

This calls for a little judicious shorting of the S&P 500, via the SPDR S&P 500 Trust ETF (NYSEArca: SPY).

I think it's time to start buying SPY puts whenever the market rallies a bit. Just be conservative - a put can always go to zero. We'll leave the reckless irresponsibility to the Fed.

Now, I can't share it here - it wouldn't be fair - but I'm giving a very specific put recommendation to my Sure Money readers, along with detailed instructions on how to allocate their capital. In fact, they're getting all my recommendations for making money while the Fed monkeys with the markets. You can click right here to start getting my research - free of charge, now and forever - three times each week.

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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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