The Fed is not going to hike

Last night bond markets bought PBOC rhetoric hook, line and sinker, selling heavily on renewed hopes for a Fed rate hike in September. Yields on the 2 year piled on 8% and the trend is very convincing:

I just don’t buy it. It would be a big mistake. Last night delivered a decent retail sales report for July after months of lousy spending but the Fed’s own GDP now measure is fading fast:

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2015 was 0.7 percent on August 13, down from 0.9 percent on August 6.

The previously reported nowcast of 1.0 percent for August 6 was revised down due to a minor adjustment in the method for nowcasting investment in computers and peripherals. Since a week ago, the nowcast for the contribution of inventory investment to third-quarter real GDP growth has declined from -1.8 percentage points to -2.2 percentage points.

This decline more than offset an increase in the nowcast of the third-quarter growth rate in real consumer spending from 2.9 percent to 3.1 percent after the release of this morning’s retail sales report from the U.S. Census Bureau.

With China pushing deflation, commodities under intense pressure, US inflation low and under intensifying downwards pressure, there is just no need to push the tightening envelope. Tim Duy agrees, from Bloomie:

I would argue that financial markets are signaling that a soft landing has already been achieved and that much additional tightening will risk tipping the economy back into recession. The Fed staff is stuck in between; at least that is the story told by theaccidental release of staff forecasts. The staff envisions a near-term policy path that better resembles what is expected by financial markets, although the staff, like FOMC participants, can’t shake its faith that eventually rates will return to something more like the historical norm.

Gavyn Davies, a former Goldman Sachs economist now at Fulcrum Asset Management, sums up the situation nicely:

Ultimately, it is of course the FOMC, not the staff, that matters for policy. In the run up to … [last month’s] policy meeting, the key members of the FOMC have seemed fairly determined to announce lift off in September. But, after that, it is debatable how far they will push their hawkish view of the appropriate path for the equilibrium rate, when they have both the markets and their own economics staff against them.

This, I think, is right.

My concern now is that the FOMC is on thinner ice than members realize because they don’t believe they have already tightened policy. The soft landing may already be upon us. They just don’t know it, or won’t admit it.

That’s a recipe for recession.

Why hike at all if that is your view? Waiting a quarter is neither here nor there. Hiking isn’t. And with China likely to continue to let markets devalue the yuan, there is no upside to a rate rise at all. Waiting six months remains my call.