The manager’s indecision is final
– Duncan McKenzie about Leeds United manager Jimmy Armfield, 1975
So after all the will they? won’t they? hype, the Federal Reserve has decided not to raise its 0.25% base rate.
Shortly before Fed chair Janet Yellen made the announcement, I was asked what the Fed could do that would shock me. I answered that three things would surprise me: that it would be decisive, show leadership and communicate clearly. There were no surprises at all. As a contact on Twitter, Brad Moseley, put it as the announcement was being made, “If you suffer from insomnia, record Yellen now & play back tonight. Sleep is guaranteed.”
In December 2008, in an attempt to help the economy recover from the global financial crisis, the Fed lowered its base interest rate – the rate at which it lends to banks – from 1% to 0.25%. It has remained there ever since, with the objective of making borrowing for businesses and individuals cheaper and thus stimulating consumption.
Ever get the feeling you’ve been cheated? – Joe Lydon (a.k.a. Johnny Rotten)
The Fed’s base rate has been touted to finally rise at least since March of this year – and several times thereafter.1 Consequently, what should have been a normal scheduled FOMC meeting was turned into a circus by the Fed’s complete loss of control of its message during the previous months (just like the taper tantrum episode2 a couple of years ago).
Early this year it seemed like they would raise some interest rates3 – but none of the rates which matter, in terms of increasing private borrowing/bank funding costs this year.
Then, in March, the Fed started to hint that a real increase was in the offing. This led some commentators to suggest it would come in June; though by May, Janet Yellen had ruled that out but said it would be sometime this year.4
Faking it
At that time it was clear to me that the Fed had talked itself into such a corner over raising rates that, if it didn’t want to lose credibility with the markets, it’d have to do something, even if it didn’t want to. Thus, it looked like the central bank would fake it. They could do that by pushing up a dummy rate like the IOER rate – the interest rate at which the Fed pays banks for depositing excess reserves; or through a base-rate increase undermined by other means, such as continued expansion of the Fed’s balance sheet and/or flattening the yield curve on treasury bonds. The latter tactic is where the Fed offers lower rates on long-term T-bonds, thus reducing the gap between the yields on short-term and long-term, making any change to the base rate less effective.
Then, in late June, came the Chinese stock market meltdown,5 which gave Mrs Yellen et al. the perfect excuse not to raise rates at all – fake or otherwise.
So, over this time the Fed had managed to confuse everyone with comments on patience6, considerable time7, data dependent8 etc. Fundamentally, the Fed had two basic choices – hike or stick. By the 17th September FOMC meeting, they’d managed to get themselves into such a pickle that, whichever one they chose, half the world would freak out.
We are being cheated
The Fed ultimately decided to stick. Not that it matters: whatever choice the Fed made would have been for the wrong reasons anyway. The world is in a major debt deflation, largely created – or at least encouraged by – the Fed, which seems to have been oblivious of this until they got smacked in the face by China’s inability to continue sweeping its problems under the carpet.9
Commentators are seeing this non-decision as throwing China a lifeline at America’s expense.10 But that’s not right either. Using emergency measures as normal policy for 7 years has created massive distortions in developed economies.11 Using extreme stimulus non-stop for so long in China has created the biggest and most widespread bubbles the global economy has ever seen.12
Yellen’s announcement just enables these distortions and bubbles to continue a while longer without being pricked. There’s a creeping sense of unease among markets that the party can’t go on forever.13 The reason that last night was so important was that markets were worried that the Fed would ‘take away the punchbowl’, the distortions would unwind and the People’s Bank of China would be unable to prevent the bubbles bursting.14 It seems to me that the markets were also hoping for some silver bullet that would mean that all the future problems would somehow magically disappear. Last night just resulted in neither any fulfilment of hopes nor any realization of fears. All that has just been put on hold for longer.
You don’t know what you’re doing!
So it seems that we’re no further forwards – we’re still in an environment where policy is all about avoiding having to face the reality. The risk is that the unwinding of distortions will lead to the bursting of global asset bubbles and an extreme crash and depression. Again, all that has been delayed a while longer.
In essence, we’ve all been cheated, not just by last night, not just since Yellen took over the reins, but by the whole Greenspan-Bernanke-Yellen unholy trinity and probably since the Fed was created in 1913. Welcome to Bubbleville!
Footnotes:
1 See various articles: http://www.bloomberg.com/news/articles/2015-04-29/
fed-still-open-to-second-half-rate-rise-despite-slowing-economy
http://www.marketwatch.com/story/yellen-repeats-fed-on-track-to-raise-rates-before-year-end-2015-07-15, http://www.telegraph.co.uk/finance/economics/11732748/
Janet-Yellen-The-US-will-raise-interest-rates-in-the-next-five-months.html,
http://money.cnn .com/2015/06/17/news/economy/federal-reserve-interest-rate-janet-yellen/
2 http://money.cnn.com/2013/06/24/investing/stocks-volatility/
3 http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
4 http://www.wsj.com/articles/yellen-says-fed-on-track-to-raise-rates-this-year-1432314091
5 http://www.mbmg-investment.com/in-the-media/inthemedia/59
6 http://www.bloomberg.com/news/articles/2015-03-18/fed-
drops-patient-stance-opening-door-to-june-rate-increase
7 http://www.wsj.com/articles/feds-considerable-time-policy-phrase-takes-focus-1418071999
8 http://www.cnbc.com/2015/09/16/federal-reserve-should-
hike-rates-because-us-is-ready-says-ubs-chairman-axel-weber.html
9 http://www.mbmg-investment.com/in-the-media/inthemedia/59
10 http://blogs.marketwatch.com/capitolreport/2015/09/17/
live-blog-and-video-of-fed-decision-and-janet-yellen-press-conference-2/
11 http://www.bloombergview.com/articles/2015-09-01/
why-the-federal-reserve-should-raise-interest-rates
12 http://www.mbmg-investment.com/in-the-media/inthemedia/59
13 http://www.theguardian.com/business/2015/sep/17/
federal-reserve-raise-interest-rates-timing-us-economy
14 idem
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