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Minyan Mailbag: Fed Policy

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Thx for the thoughts!

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Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next discussion with that very intent.

This morning I forwarded Minyan KD the notes from Merrill Lynch economist David Rosenberg's conference call yesterday. David made the point that a slowing economy, which is implied in the yield curve, happens to benefit defensive stocks in a strong way, and provided data to support the thesis. Interestingly, Minyan KD yesterday morning pinged me and said his indicators are showing a strong relative strength move for these defensive names and food stocks in particular. Below is our back and forth...


Scott Reamer: Interesting stats vis-à-vis your bullish comments on food stocks (and other defensives).

Minyan KD: It is also interesting to note that EVERY report I've read (BCA, this one, a couple of others from the major retail houses) is so ambivalent about the deteriorating price indices. Continued ".01 increases on the core PCE deflator...would take y/y trend down to 1.2% by April....lower than the 1/4% trend ....during deflation scare, mid 2003."

So the Fed is tightening to tame core inflation and "economic growth" while virtually every indicator is screaming deflation.

They are desperate. Moreover, the Bush budget, being politically "portrayed" as a "belt tightening" budget, highlighting "cuts" seems to be PRECISELY the psychological mindset the Fed is MOST AFRAID of. I absolutely believe the Fed understands very clearly the psychology of deflation. Otherwise, there is virtually NO evidence to support their continued series of rate hikes. They have embarked on a mission to psychologically support an anti-deflation, consumer-spending supported economy by maintaining for as long as possible the housing leg of the economy. Their "experiment" is failing.

One thesis might be that commodities demand (especially from China) has been overestimated, and that commodities have been awakened from their secular bear market by virtue of diminished capacity disguised as important increases in demand. These signals have been misread by the Fed as an inflationary backdrop. Instead, what their experiment has wrought is an echo bubble in stocks, an extension in the bubble in housing, and now a bubble in commodities that is beginning to be unwound as the market realizes the error. What do you think?

Scott Reamer: Extraordinarily insightful K; I agree. On one point however I would say this:

You said:

"I absolutely believe the Fed understands very clearly the psychology of deflation. Otherwise, there is virtually NO evidence to support their continued series of rate hikes. They have embarked on a mission to psychologically support an anti-deflation, consumer-spending supported economy..."

I too believe they rationally understand the economic impact of deflation on a heavily indebted economy. However, instead of responding to these dynamics rationally, they are, like every other actor caught up in this mass economic psychosis, acting irrationally in their policy. Which is to disagree with your point: a rational response to these circumstances would NOT be to "embark on a mission to psychologically support an anti-deflation..." So indeed, though they understand the concept of deflation in a rational sense, their response to it is entirely irrational b/c of the continued bullish (inflation) bias they find themselves in and cannot escape. After all, one would expect economic actors that are altogether removed from the day to day workings of an economy to be the last to 'realize' what is actually happening on the ground and thus the last to give up the reflexive policies of the past when inflation was the big boogeyman.

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