FORGET ABOUT NFPs - Everyone is waiting to digest today's monthly employment report out of the US, and the data is sure to generate volatility. But if we think about the direction of Fed policy over the past few months, how much volatility can we really expect? The Fed has not made our life easy with its guidance, and the irony is the more "transparent" the central bank becomes, the harder it is to figure out where it is going (another Fed irony to come). We saw Bernanke tie monetary policy directly to unemployment, only to distance himself from the metric shortly thereafter. And now that the Fed has opted to go qualitative with its approach (not exactly transparency's best friend), after saying that rates would go up well after unemployment dipped below 6.5%, today's major release shouldn't arguably carry with it as much market moving influence as it once did. So where is the Fed's focus now? It's pretty clear that inflation is now the en vogue metric. The Fed wants to buy as much time as possible before being forced into a policy shift. Whichever metric is further away from backing them into that corner is going to be the metric of choice. And so, "well anchored" inflation it is, at least for now.
THE BIGGEST IRONY - But time is running out, and just as unemployment came down quicker than anticipated, inflation is just as capable of shooting up ahead of forecast. If the previous reading is any indication, we could be threatening 2.0% very soon. So while this latest policy meeting was a non-event, pay attention to today's employment report and more importantly, the upcoming inflation data. Should we see another drop in the unemployment rate (or even stable), and an uptick in inflation beyond 1.5%, look out for major fireworks in June. The Fed will be forced to start to talk a little tougher and back away from this ultra accommodation. I am of course of the opinion that the central bank should get on with it already, as there is now a very real financial stability threat, with asset prices unjustly elevated on the back of this free money economics. Investors are starved for yield in this artificial interest rate environment, and have been pressured into taking on riskier bets to make up for the lack of yield. This is a recipe for a major bubble, and will only perpetuate the very problem the Fed has been trying to remedy over the past several years. One crisis may beget another if the central bank doesn't act fast. So while the Fed doesn't want to think about policy reversal, I think it best they do, or risk another meltdown. The biggest irony of all is that in responding to the 2008 collapse that was brought on by reckless investment, the Fed came up with a strategy to stimulate the economy by forcing investors into risky investment. Food for thought.