Let the Mutiny Begin!

This week, the Federal Reserve left interest rates unchanged, and three members of the Federal Open Market Committee (FOMC) dissented (gasp!) at the majority recommendation.

Two Fed watchers (it's a job, I guess) are suggesting those members may lead a mutiny before the next Fed meeting.

All because Fed chair Kevin Warsh didn't raise interest rates by 25 basis points (0.25%).

A rate increase of that magnitude would have little to no impact on inflation (current or future).

But darn it, at least the Fed would be doing something!

But that's the problem. For too many years, the Federal Reserve has been doing things.

And in many cases, they've been doing the wrong things.

It's not because they're stupid. These are bright economic minds.

But it's hard to make sound decisions when they're informed by bad data.

That's what Warsh telegraphed to anyone listening to his first press conference after the June FOMC meeting. One example he used was the Bureau of Labor Statistics (BLS) Jobs report, which isn't considered final until three months after it's released.

And in the last few years, those three months have brought substantial revisions that would call into question any policy decision, like a 25 basis point cut or hike.

So, Warsh has created a task force to identify the best sources of data for the FOMC to consider in its policy-making decisions.

But task forces take time. And we have to do something. RIGHT NOW!

Doesn't Warsh realize that the CPI, PPI and PCE inflation numbers are well above the Fed's stated 2% target and that the conflict with Iran is causing oil prices to drift higher, and that means that inflation is going to start running hot again...?

Asking those questions of Kevin Warsh is like asking him if water is wet. Of course he knows it.

Which brings me to another point Warsh made in June. He wants markets to function without relying on assumptions about how the Fed will respond to future developments.

Instead, he had the audacity to suggest that markets should price policy expectations based on incoming economic data rather than Fed guidance.

The horror!

But sadly, that's exactly what seems to be driving investor discontent. Greg Ip of The Wall Street Journal opined:

"Markets respond not just to data but to how they think the Fed will respond to data. Investors plug each new bit of information into the Fed's assumed "reaction function," which then spits out the appropriate interest rate.

If the markets correctly understand the Fed's reaction function, then they can do some of the Fed's work for it...But this only works if the Fed actually behaves as markets expect."

Yes, Greg and that's been the problem.

The markets have relied on the Fed to do its work for it, not the other way around. In the process, markets can never correct. Bubbles can never really pop. The market has become "too big to fail."

This isn't a failure of Warsh to communicate. It's a failure of others to listen.

But I hope Warsh is listening. I hope he's listening to data that may be inconvenient to some FOMC members. Data such as:

• An uncomfortable number of citizens under 30 years old are still living with Mom & Dad.
• A surge in bankruptcies (both individual and business)
• As of the latest Truflation data, U.S. inflation is reported at 2.10% year-over-year for the Truflation US CPI Inflation Index

None of that gets better with higher interest rates.

It's almost as if the economy and the stock market are different. Spoiler alert, they are!

Which is why, I believe, Warsh is on the right track. Reform is needed. Not reform for the sake of reform, but reform so that better decisions can be made.

I like the nuance that analytics has brought to professional sports. But I dislike how it's become a crutch for coaches to stop coaching the game being played in front of them.

That's what's happened with the Fed and the markets. If the markets get things wrong, they blame the Fed. If the Fed gets things wrong... (oh wait, the Fed doesn't get things wrong, that was just a transitory thought).

As you can see, I'm too cynical to be overly optimistic. I can see a world where we're back to navel-gazing on meaningless dots and hearing about the "Warsh put" in mere months.

But he's only been at the helm for a short time. The definition of insanity is doing the same thing over and over again and expecting a different result.

That's described the relationship of the Fed and the markets for too long.

I'm rooting for reform.

I want the family fight.

And if mutiny must happen. Bring it on!