(Source: Federal Reserve, caption by the Author)

The Fed has tried to downplay expectations for the November FOMC meeting, as being too early for any action to be taken under its new monetary policy framework. Unfortunately for the Fed, economic and political events are conspiring to force the FOMC’s hand. This could not have come at a worse time for the Fed, as there are signals that all its members are not on the same page when it comes to interpreting how the new monetary policy framework should be applied.

The recently released minutes of the last FOMC meeting revealed that opinion is widely dispersed on what exactly to do, although there is consensus to let inflation overshoot target and employment to be the best that it can be under the circumstances. This dispersion suggests that the Fed hasn’t quite come to grips with how to execute its new monetary policy framework.

Whilst the Fed fumbles around, for the right process and procedure, to finesse its new monetary policy framework, the US economy is showing signs of decelerating. A further headwind is being created by political uncertainty and the specific antics involved in the Presidential election campaign. This political headwind has also become economic as talks over a new fiscal stimulus have broken down.

The Fed’s time and space to get to grips with its new monetary policy framework are, thus, compressed and challenged respectively. Usually, these hurdles end in a volatile market event that then forces the Fed to react, rather than to act with foresight and prescience. This modus operandi seems to be happening again. The November FOMC meeting is, thus, becoming more significant than the Fed would like it to be in an election year. The FOMC would have liked to sit out the election, but events may conspire to force its hand against such better judgment.

(Source: Federal Reserve Board)

The latest Fed study of US Family Finances, from 2016 to 2019, showed that broadly measured, income and wealth disparities were narrowing before the COVID-19 pandemic struck.

(Source: Federal Reserve Board, caption Mathew 22:21)

Whatever may be said, about his current behavior and performance, President Trump can and surely will take credit for this pre-COVID narrowing of wealth disparities. The Democrats will claim that they are a trailing moving average from the Obama era. Since then, the disparities have widened. This widening is not just driven by the health impact of the COVID-19virus. It is also driven by the Fed’s own monetary policy response. The Fed is both a part of the problem and the solution.

(Source: the Author)

The Fed is clearly aware of its specific role in the widening of divisions in society and is keen to adopt a make-up strategy solution in line with the other make-up strategies in its new monetary policy framework. This remedial solution has been termed the Inclusivity Mandate by this author.

(Source: Federal Reserve Board, caption by the Author)

This author has characterized the US Economy as a “tale of two cities”, that are inhabited by the asset-rich and the asset-poor. The Fed’s response to the COVID-19 pandemic has been generally helpful to the asset-rich but has not really touched the asset-poor.

(Source: Reuters)

Evidently, Cleveland Fed president Loretta Mester also believes in this “tale of two cities”, since she has used the same analogy in her recent commentary. Her nuanced guidance suggests that the Fed will be more focused on the asset-poor going forward.

(Source: Atlanta Fed, caption by the Author)

A recent study of the labor market, from the Atlanta Fed, suggests that the employment situation is complex and far away from healing. The report also finds a “tale of two cities”, in essence. Temporary unemployment was hit the hardest, by the pandemic, but is recovering swiftly; even though it is a long-way off pre-pandemic level. Temporary layoff unemployment rose in the order of ten times that of the GFC experience. By contrast, permanent layoff unemployment did not get hit as hard, but neither is it recovering. Indeed, permanent layoff employment continues to deteriorate and is now about halfway back to the GFC peak.

The weak contractual safety in temporary work is clearly visible in the data. These workers didn’t get furloughed, they just got laid off the first because it was easy to do so for their employers. Temporary workers were not touched by the emergency support programs from the Fed. The strong recovery in temporary work may also be a symptom of the fact that it is cheaper to employ and easier to fire if things don’t play out well. The Gig Economy is clearly making quantum-leap progress in the economic recovery. The growth of the Gig Economy is a mixed blessing, that is better for the employer than the employee.

The weak contractual safety in temporary work is clearly visible in the data. These workers didn’t get furloughed, they just got laid off the first because it was easy to do so for their employers. Temporary workers were not touched by the emergency support programs from the Fed. The strong recovery in temporary work may also be a symptom of the fact that it is cheaper to employ and easier to fire if things don’t play out well. The Gig Economy is clearly making quantum-leap progress in the economic recovery. The growth of the Gig Economy is a mixed blessing, that is better for the employer than the employee.

The Fed’s pretensions, to be aiming for maximum permanent employment, could be in place for a decade.

It remains to be seen if the Gig Economy style improvement, in maximum temporary employment, can be achieved at the current pace.

The Fed cannot be happy with the ill-health of the permanent layoff unemployment data. Even if the Gig Economy gets temporary layoff employment back, to pre-pandemic levels, this will not be a cause for celebration; nor will it be a likely cause for the normalization of monetary by the Fed.

America’s labor market is inextricably broken and the returns to labor are under further erosion. This bodes ill for consumption. It also shows why the Fed is so keen to get the Federal Government to throw some more fiscal stimulus at the problem.

(Source: Boston Fed, caption by the Clash)

The temporary layoff workers are the basis of the asset-poor. They will also be joined by those who are getting permanently laid off on the rising trendline. To make things worse, since these folks are a bad credit risk, they are also punished by the credit creation process according to the Boston Fed.

The asset-poor is thus denied leverage and the chance to get out of the hole. The market has failed them and politicians, on both sides of the House, have abused them in order to get elected. The Fed now feels that it is time that they got a break before the US polity is divided further into something that can never be made whole again. This asset-poor cohort, who make up the growing contingent of the weak pricing power of labor, are the intended recipients of support under the Fed’s Inclusivity Mandate.

To frame the issue in terms of behavioral economics, the New York Fed has also found that, whilst both groups over-estimate their ability to avoid the COVID-19 virus, the asset-rich are over-confident relative to the asset-poor. Thus, whilst it is believed by both groups that the virus is someone else’s problem, the asset-poor do not believe this to be the case as strongly as the asset-rich. The real-life experience of the virus seems to have modified confidence. The virus has had a diverse impact on physical health, and the perception of physical health that is determined from the position of economic status.

This author believes that the focus on the asset-poor will come from the Fed’s positioning of the Community Reinvestment Act (CRA) as an unconventional monetary policy tool for its semi-official Inclusivity Mandate. This mandate was defined by Chairman Powell, in the Fed’s new monetary policy framework, as a commitment to “Inclusive” maximum employment.

The Fed’s focus on inclusivity is initially appearing as an abandonment of the asset-rich. This appearance has come as a great shock to Mr. Market since the Fed has fluffed its guidance in communicating this new emphasis. This garbled message, from the Fed, is in part due to its unwillingness to admit that it is part of the problem. Consequently, a risk-off sentiment from the asset-rich is threatening to become an economic headwind, that will also negatively impact the asset-poor, since it is being interpreted as a premature normalization of monetary policy per see.

(Source: bertrandrussellquotes)

The Fed may find that going forward, it will have to conflate the fortunes of the asset-poor and asset-rich more closely. Consequently, economic inequality will continue to widen. This is why the Fed Chairman is so insistent that a fiscal policy aimed at inequality is so critical. Unfortunately, for the Fed, the US presidential election is polarizing the debate between the asset-rich and asset-poor, which is negatively feeding back into the Fed’s ability to exclusively follow its Inclusivity Mandate.

Simply put, the Fed has too many, sometimes, conflicting missions. The US central bank is, thus, set-up for mediocre performance in achieving all its objectives. The new monetary policy framework is, therefore, inherently flawed from its inception. Elected policymakers’ failure to be inclusive, at the national level, just makes the situation worse. This is the curse of democracy in its present form. COVID-19 has simply put this dialectic into much sharper relief. As Churchill noted, however, this system is viewed as better than the alternatives; at least by some of those who make the rules and some of those who vote!

(Source: Gallup)

It should be noted that Churchill also said that Americans will always do the right thing after exhausting all the alternatives. The Fed and the American people, therefore, have to trust the democratic process and their Constitution, to deliver in the long run, maybe ultimately via the Supreme Court. But, as Keynes observed, in the long run, we are all dead anyway!

The last report discussed the growing disquiet amongst some Fed officials about the perceptions that it was stepping back from its commitment to provide further monetary policy stimulus to push inflation and employment to their targets. Boston Fed president Eric Rosengren was particularly concerned to correct this misconception. His concern has strengthened. In recent enhanced forward guidance, he admitted that “I’m (Rosengren) very worried that we’re pretty far away from what we think is maximum employment and I think there are going to be significant headwinds to getting there quickly.”

St. Louis Fed president James Bullard continues to be a thorn in the side of Chairman Powell and those others concerned about the growing perceptions that the Fed is stepping back. To be fair, Bullard has toned it down a little from his initial outburst that the economy may not need a further fiscal stimulus. Now he opines that ceteris paribus, GDP could return to 2019 levels quickly. Bullard resolutely continues to be a communication headache for Chairman Powell. His latest guidance continues to question whether another fiscal stimulus is needed this year.

(Source: the Author)

After Fed Governor Lael Brainard’s earlier signal, New York Fed president John Williams has recently re-confirmed that the Fed will pursue its Inclusivity Mandate, via the Community Reinvestment Act (CRA), whilst also re-affirming his commitment to the Black Lives Matter cause.

(Source and caption by the Author)

The last report discussed the general shocker of collective Fed guidance, post-recent FOMC meeting, specifically the howlers emitted by Chicago Fed president Charles Evans. So poor was Evans’ communication, that he felt or was physically compelled to redact it. His redaction was even more comical than his initial boo-boo. Apparently, when he first spoke, he thought that he was reading verbatim from the last FOMC statement, rather than any signal that the Fed would start normalizing monetary policy prematurely as initially understood. This answer is just not plausible, which is making Evans’ tenure on the FOMC untenable without some serious remedial guidance schooling. Evans is still in recovery mode, hastily trying to dovetail his own commentary with that of the new monetary policy framework’s overshooting bias themes. Apparently, now, Evans is “in it to win it”! In this monetary policy contortion, he confidently expects inflation to hit 2% and will then allow it to overshoot as far as 2.5%.

(Source and caption by the Author)

This Evans mess only serves to underline the observation that Chairman Powell should have changed the communication framework in addition to the monetary policy framework since extended forward guidance is an unconventional monetary policy tool after all. It also suggests that, as this author reasons, the Fed may still not yet understand how to translate the new monetary policy framework into guidance and words. Vae Mr. Market! Thus, the Fed and the next administration may have to overcompensate with monetary and fiscal policy vade mecum.

Although clearer than Evans, Philadelphia Fed president Patrick T. Harker’s guidance is riddled with plot-holes relating to assumptions and conditions. He remains cautiously optimistic. His optimism, however, assumes strict observance of COVID-19 healthcare protocols, a new vaccine by the spring, and also a fiscal stimulus well before then.

Somewhere, in the middle of the guidance spectrum, is to be found Philadelphia Fed president Patrick T. Harker. In this broad middle ground, Harker is able to support the Inclusivity Mandate, not just on moral grounds, but also because it boosts economic activity.

New York Fed president John Williams’s recent guidance was almost so vague that it almost had no practical value, other than to confirm that the Fed is committed to “purposefully” letting inflation overshoot “for some time”. To be fair, he did put a figure of three years on the time taken to reach full recovery that provided an indication as to how long “for some time” maybe. To give him the benefit of the doubt, he probably does not want to lock the Fed into any pre-commitments at this stage, which is fair enough. This view scans with Robert Kaplan’s reprise of his reason for dissenting at the last FOMC meeting.

For those who missed his previous explanation, Kaplan recently repeated that he wishes to give his colleagues some flexibility in the future; by allowing scope for a rate increase into the lexicon of guidance. Kaplan also showed that he is a good team player, by affirming his commitment to the Inclusivity Mandate in support of those who have been left behind by the Fed’s actions to date.

In an attempt to draw a line under the matter, Kaplan has changed the debate. He believes that Mr. Market should question his own faculties rather than the quality of Fed guidance. Apparently, the Fed has been very clear about where interest rates will be over the medium-term. Mr. Market should focus on this clear signal rather than waste his energies on second-guessing what he thought that he might have also heard.

At the other end of the dissenting guidance spectrum, Minneapolis Fed president Neel Kashkari is brandishing a “double-edged sword”. He foresees a “grinding recovery”, that is in need of further fiscal stimulus. His “double-edged sword” is derived from the fact that the healthcare protocols, which have been relaxed to boost the economic recovery, will deliver a blowback in the form of a pandemic spike. Kashkari, skillfully, used the weaker points in the latest Employment Situation report to underline his case and to loose the fateful lightning from his terrible “double-edged sword”. His truth and guidance are marching on!

To compound the Fed’s guidance misery, there is now evidence that its Main Street Lending Program (MLP) is not working either. The latest Senior Loan Officers Survey found that approximately half of the group had not used the MLP. Furthermore, the bankers claim that the program has not been utilized because its terms and conditions, set by the Fed, are too restrictive. This clearly explains while most Fed speakers (sans-Bullard) are crying out for more fiscal stimulus. Their cries will also, hopefully, distract observers from observing that the MLP has failed. Such an observation would not reflect well on the program’s administrator Boston Fed Governor Eric Rosengren. It is becoming clear that the program should be scrapped in its current form and replaced with something more impactful. Unfortunately, impactful means riskier lending. Only a central bank or Federal agency can take this increased risk.

Kansas City Fed president Esther George anticipated the bad news on the MLP. She presciently warned that the banking sector is still at risk from further poor loan performance. In such a weak state, it is no surprise that senior loan officers have not embraced the MLP wholeheartedly.

The banking sector which, in effect, is a stakeholder in the Fed is increasingly becoming an obstacle to monetary policy for the US central bank. The Fed’s restrictive terms for the MLP are in essence an attempt to preserve the stability of the banking sector so that it can continue to be a transmission mechanism for monetary policy. In this instance, the banks won’t lend and actually blame the Fed’s restrictive terms for not lending. Allegedly, the Fed is not trying to protect them but to put them (and the US Economy) out of business!

(Source: Cleveland Fed, caption by the Author)

A similar banking system obstacle can be found in the case of negative interest rates. The last report noted that, by many Fed rules of thumb, negative interest rates should have happened in America by now.

(Source: San Francisco Fed, caption by the Author)

A recent report by the San Francisco Fed sheds some light on why they have not seen NIRP. The researchers conclude that the compression of lending margins, by failure to pass on negative interest rates, undermines the banks’ ability to create credit and weakens their operations. If the Fed has not attempted negative interest rate policy, this is in part due to the power of the banking sector within the ownership and governance structure of the central bank. The banks don’t want NIRP and will do anything that they can to suppress it.

(Source: San Francisco Fed, caption by the Author)

The San Francisco Fed’s first report was supported with a more detailed technical exposition on the transition mechanism and the impacts on it from negative interest rate policy by central banks.

Negative interest rates are, clearly, a conundrum that the Fed and the US commercial banks have not yet come to terms with. Nor does it seem that they have any intention of positively coming to terms with negative interest rates any time in the foreseeable future. Clearly, also, the San Francisco Fed is interested in the matter and (clearly) its concern is a signal that the Fed and the banks too are concerned.

It is becoming clear that the banks want the Fed to continue its current policies, which favor the asset-rich and hence the banks’ loan portfolios. The banks are one of the biggest obstacles to the Fed’s Inclusivity Mandate by their aversion to the MLP. They have increased the obstacle in size, by refusing to even practically test if NIRP is the headwind that they say it is. They may, thus, be one of the biggest obstacles to the monetary policy transmission mechanism.

(Source: Federal Reserve Board, caption by the Author)

The Fed is toughening its stance, with the banks, however. Most recently, the cap on bank dividend payments has been extended to year-end.

Firstly, this dividend cap extension stops the banks from using the Fed’s emergency liquidity to enrich their shareholders rather than transmitting it to the real economy. This may nudge the banks into reconsidering their attitude towards the MLP, but this is unlikely.

Secondly, the Fed has hinted to the banks that low interest rate pressure, perhaps even negative interest rate pressure despite what the San Francisco Fed says, is here to stay for much longer. US banks are, thus, being nudged to change their cozy parochial business models and cozy relationship with the Fed, in order to adjust to the new economic normal. The BOJ did the same thing after it had unleashed NIRP. The Fed is giving the banks a heads up and support in preparing for NIRP. The entitled banks are pushing back.

Bowman’s commentary bigged-up the Community Banking sector for doing the heavy lifting in the, so far, unspectacular performance of the MLP. Fed Governor Brainard then followed up on Bowman, with her own explanation of how the Fed is engineering a greater focus on the Community Reinvestment Act (CRA) and its delivery, via the community banks, to execute its Inclusivity Mandate. It is, therefore, logical to conclude that any further modifications and expansion of the MLP will be aimed at the Community Banks. In fact, it may be reasonable to say that the Community Banks will be the main mechanism for the MLP and Inclusivity Mandate. It would be ironic, but not entirely surprising if they were also chosen and supported in transmitting NIRP in the future.

(Source: Atlanta Fed, caption by the Author)

As expectations of a 25 basis point rate cut, by mid- December, fall towards a steady lower probability of a rate hike by the same amount, one should not, however, exclusively blame the commercial banks for obstructing NIRP.

The Fed’s own inflation mandated inertial guidance is, perhaps, the greatest obstruction to NIRP. It is, also, fair to say that this obstruction is reasonably based on empirical evidence. A recent report from the Cleveland Fed sheds some light on this subject matter. It also helps, in some way, to explain why the Cleveland Fed president Loretta Mester has been a historic monetary policy Hawk who has been forced to embrace the seemingly bizarre Dickensian guidance, about a “tale of two cities”, of late. It all comes down to how one measures inflation, it transpires.

(Source: Cleveland Fed, caption by the Author)

The Fed’s own inflation measure of the PCE has a headline and a median sub-measure. According to the report, the Headline PCE is volatile and overly influenced by energy and electronics goods prices. Currently, in the pandemic, these components have pushed the Headline PCE well below both the Median PCE and the Fed’s average inflation target.

Consequently, the Headline PCE is saying NIRP and the Median PCE is saying prepare to normalize. Who is right?

For the record, the Median PCE has been a more accurate historic measure of inflation than Headline PCE. This track record was, however, before COVID-19. It is not clear to anybody how much COVID-19 has changed things.

In the meantime, Fed judgment and guidance must span the divergent gap, between Headline and Median PCE, and try to remain credible at the same time. Failure to credibly span this gap can be reasonably expected. It does not mean that the Fed is doing anything wrong. It simply means that the Fed doesn’t really have a firm handle on where inflation is headed. Under such conditions, approving a new monetary policy framework, that has an innate inflation overshooting bias, is a risky thing to do. Faced with the COVID-19 reality, the Fed has been forced to throw a great deal of caution to the wind. Having, thus, gambled it is reasonable to expect the Fed to be circumspect about doubling down on the wager. It is, therefore, now clear why Robert Kaplan dissented and tried to give the FOMC some optionality to normalize swiftly.

All this being said, the Fed’s pandemic response has provided a great amount of liquidity upon which inflation can converge towards and overshoot its target. It is, therefore, no surprise that the Fed wishes to drag its heels and leave Congress to do the heavy lifting on economic stimulus. It will be no surprise, either, to see the Fed refraining from easing further and increasing the pressure for fiscal stimulus going forward. A tantalizing (and destructive) prospect of a game of bluff is, thus, being set-up between the Fed and Congress.

Under these conditions, it is also fair to say that bonds are very richly priced unless one believes in a total COVID-19 related disaster that calls for NIRP. Low bond yields are currently being capped by Fed buying. Any relaxation, of the pace of Fed-buying, would cause a sharp spike in yields. Barbell bond investing strategies, which involve TIPS, may become the best way to play out this divergence, between Headline and Median PCE, until the real path of inflation becomes clearer.

(Source: Federal Reserve Board, Morse Code signal by the Author)

Chairman Powell did his level best to avoid committing to a new round of bond-buying with his eloquent request for additional fiscal stimulus. This plaintive speech was consistent, with the overshooting monetary policy framework theme, that the threat of over-doing it with a fiscal stimulus is well worth the risk against doing nothing. Philadelphia Fed president Patrick T. Harker then underlined the request for the fiscal cavalry to come to the rescue. They needn’t have bothered after the Lazarus halo-effect, from the recuperating POTUS, shredded their guidance.

(Source: forexlive, caption by the Author)

COVID-19 Positive POTUS recalcitrantly ruled out any new fiscal stimulus until he wins the election. Even if he does not win, this means that there will be no new fiscal stimulus until a new administration is sworn in. All the recent Fed speakers’ baseline scenarios and guidance, which assume a fiscal stimulus, are, therefore, meaningless. The balance of risks is, thus, tilted to the downside and the pressure is on the Fed to gamble even further against its current better judgment. If the Fed gambles, and eases further, then the next fiscal stimulus is potentially the event that will stimulate the inflation rebound that the Fed says it wants to let overshoot but, in practice, is totally scared of.

Loretta Mester’s initial reaction to the fiscal stimulus news, clearly, showed that the Fed does not want to be drawn into easing again without the markets and/or the economy experiencing some pain. Her initial take is that the recovery is still on, but it will take longer without a fiscal stimulus. This would all have been well and good had not Chairman Powell been so plaintive about the need for stimulus and so brazen about being tolerant of economic overheating risks.

Since Chairman Powell nailed his colors to the wall, by saying that the risk of overheating is worth taking, he is, therefore, obliged to ease again; or risk looking like a hypocrite and thereby undermining the new monetary policy framework from inception.

Dissenting Minneapolis Fed president Neel Kashkari smells blood in the water and is circling for the kill at the November FOMC meeting. He sees “enormous consequences if we (the Fed) just let things go, and the downturn will end up being much, much worse.” The failure to enact a fiscal stimulus is his baseline, from which to wreak havoc at the meeting. Just to add to the pressure, on Chairman Powell, Kashkari has also opined that further monetary and fiscal policy stimulus, under current circumstances, does not add up to an increase in moral hazard risk per se. Bold words indeed.

New York Fed president John Williams can foresee trouble at the November FOMC meeting and is trying to provide a contingency with some remedial guidance. Rather than get tied down on method, indicators, and targets Williams has created the notional concept of a “guardrail” to define the nebulous concept of inflation target overshooting. He hopes that this is acceptable to his colleagues and Mr. Market so that the Fed retains the luxury and the option, to shoot from the hip, whilst it wrestles with its new monetary policy framework doctrine. Hope has never been a monetary policy tool. In the current environment, it is unlikely that Williams’s “guardrail” will hold against a strong market and/or economic impact.

Chicago Fed president Charles Evans is already procrastinating again; his default-setting when he wishes to put off the inevitable. For now, he believes that the FOMC can stand pat and hopes that this will still be the case come the November FOMC meeting. His procrastination signals that he is more worried that this will not be the case.

Robert Kaplan and Eric Rosengren have appeared to blink, although Kaplan is still far from happy about being arm-wrestled into easing again.

Kaplan stuttered that the Fed is capable of doing more, but that fiscal policy would deliver more bang for the buck. He also intimated that he will be “skeptical” about doing more QE, and hence that he will dissent if and when this decision is taken at the next FOMC meeting. His FOMC dissent may also be qualified with his insistence that language incorporating a taper, when the economic situation allows, accompanies further easing.

Eric Rosengren opined that it will be “tragic” if another fiscal stimulus is not agreed upon. In addition, Rosengren noted that most firms went into the pandemic with greater leverage which is now acting as a headwind. They both were resigned to the fate that another fiscal stimulus may have to wait until the new administration is sworn-in. The inference is that they would agree to a monetary policy stop-gap expansion to fill the void until the fiscal stimulus comes.

The November FOMC meeting is a long way away. Getting there is going to be volatile and tortuous.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.