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Weekend Reading: Fed Rate Failure

Submitted by Lance Roberts via STA Wealth Management,

Over the last year, I have written extensively about how despite the Fed's best intentions to raise rates, the real economic backdrop would likely impose a major impediment in doing so. However, I also suggested that with the Fed now caught in a liquidity trap, they would potentially hike rates to avoid being caught at zero during the next economic downturn. To wit:

"Currently, there is little evidence that is supportive of higher overnight lending rates. In fact, the current environment continues to support the idea of a 'liquidity trap' that I began discussing in 2013.

 

'...a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.

 

Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.'

 

Please review the chart on monetary velocity above. This is a major issue for the Federal Reserve, which remains firmly committed to a line of monetary policies that have had little effect on the real economy.

 

While the Federal Reserve clearly should not raise rates in the current environment, there is a possibility that they will anyway - 'data be damned.'(Which is ironic for a 'data dependent Fed.')

 

They understand that economic cycles do not last forever, and that we are closer to the next recession than not. While raising rates would likely accelerate a potential recession and a significant market correction, from the Fed's perspective if just might be the 'lesser of two evils.' Being caught at the 'zero bound' at the onset of a recession leaves few options for the Federal Reserve to stabilize an economic decline. The problem is that it already might be too late."

The current surge in deflationary pressures is not just due to the recent fall in oil prices, but rather a global epidemic of slowing economic growth. While Janet Yellen addressed this "disinflationary" wave during her post-meeting press conference, the Fed still maintains the illusion of confidence that economic growth will return shortly.

Unfortunately, this has been the Fed's "Unicorn" since 2011 as annual hopes of economic recovery have failed to materialize.  

"The problem for the Federal Reserve is that they are still looking for that elusive economic recovery to take hold after more than five years. Unfortunately for the Fed, economic recovery cycles do not last forever, and the clock is ticking."

This weekend’s reading list is dedicated to the views surrounding the latest Fed announcement. What are they really saying? What impact does that potentially have for the markets? And what will they do if a recession rears its head? 


THE LIST

1) Federal Reserve And Economy Stands Pat by Steve Forbes via Forbes

“THE FEDERAL RESERVE'S announcement that it will continue to suppress interest rates is going to harm the economy. We won't be breaking out of the rut we're in, which is bad news for us and the rest of the world.

 

The Federal Reserve thinks its zero-interest-rate policy stimulates the economy, but it's actually doing the opposite. It's the equivalent of bleeding an anemic patient.

 

In a nutshell, if a product can't be properly priced, you get less of it, and you get distortions in how that market operates. Alas, our central bank remains obtusely ignorant of this basic truth.

Read Also: Fed Gives Economic Growth A Chance by Editorial Board via NY Times

 

2) Central Banks Missing What They Don't Know by Jeffrey Snider via Real Clear Markets

“It was no surprise the FOMC failed to find its own exit this week given that a few days earlier Deutsche Bank announced yet another restructuring including massive layoffs. It doesn't appear as if any of those job cuts will be applied to US operations, which seems to render this a quite curious correlation with domestic monetary policy. If you like, you can substitute Citigroup's 5% decline in FICC "revenue" this quarter, or Jefferies Group 50% collapse in fixed income losses (tied to the corporate bond bubble, no less). It's all one and the same.

 

On the surface, the relationship between banking and the Fed seems to be just that straightforward. In very general terms, interest rate targeting is supposed to reduce the "cost" of funds for banks so that they can "earn" a greater spread to the assets they hold or will hold. If only it were as easy as economists believe.”

Read Also: Janet Yellen Did The Right Thing by John Cassidy via The New Yorker

 

3) Negative Rates Coming To The U.S.? by Tyler Durden via ZeroHedge

“Of course, this should come as no surprise to our readers: just in January we wrote "Get Ready For Negative Interest Rates In The US", but for the Fed to admit this possibility just when it was widely expected to at least signal a rebound in the economy with the tiniest of rate hikes, or at worst a hawkish statement, was truly a shock.

 

This is what she [Janet Yellen] said:

 

'Let me be clear that negative interest rates was not something that we considered very seriously at all today. It was not one of our main policy options.'

 

'I don't expect that we're going to be in a path of providing additional accommodation. But if the outlook were to change in a way that most of my colleagues and I do not expect, and we found ourselves with a weak economy that needed additional stimulus, we would look at all of our available tools. And that would be something that we would evaluate in that kind of context.'

Read/Watch Also: Ray Dalio Worried About Downturn by Katherine Burton via BloombergBusiness

 

4) Fed Delay's Interest Rate Lift-Off by Jon Hilsenrath via WSJ

"The decision left uncertain for a while longer just when the Fed would raise its benchmark rate, which has been near zero since December 2008. Most of the policy makers at the meeting, 13 of 17, indicated they still expect to move this year, but that was down from the 15 who held that view in June. The central bank has two more scheduled policy meetings this year, in late October and mid-December.

 

One reason for the shifting outlook: Officials have become a bit less optimistic about the economy's long-run growth potential. They projected the economy will grow at a rate between 1.8% and 2.2% per year in the long-run, down from their June estimate of growth of 2.0% to 2.3% in the long-run. A more lumbering economy has less capacity to bear much higher rates."

Read Also: Fed To Economy: Party On, Not So Excellent by Brian Doherty via Reason.com

 

5) A Roadmap For Stocks After No Rate Hike by Michael Kahn via Barron's

"Given the volatility levels today, it is important to step back to look at the bigger picture. After all, the major trend and structure of the market provides the framework within which the short-term condition operates.

 

For example, if the bull market is still intact, then the spin on the Fed news will be positive even if on the surface it seems it is not. And if this is a bear market, then the spin will most likely be bad. Stocks should fall further.

 

While the bull market seems to be over, thanks to a rather convincing breakdown of the major trendline and 2015 trading range, I do not yet see enough evidence to conclude this is a major bear market (see Chart 1). I need one more price breakdown to get there."

Read Also: Fed Makes Same Mistakes As It Did In 1927 by Martin Armstrong via Armstrong Economics


Other Reading


“Nothing is more suicidal than a rational investment policy in an irrational world.” – John Maynard Keynes

Have a great weekend.