On August 3rd I predicted that the Fed would keep its bank base rate zero at it’s Setpember meeting that ended yesterday (see Which way is up? US interest rates and the case for 2016). I had suggested that by taking a broader, global view, the Fed would override the pressure for a rate rise that is more likely if one took a US domestic view. So that is that. Next up is the question of when will the Fed increase rates? I suggested 2016. I am more confident that it will be early 2016 and more likely be February or March.
Even though most economists are now sighing and predicting that market stability will improve, I am not buying that. Volatilty for me is more a factor of the amount of QE that has pumped billions of dollars, euros, yuan and yen into the stock markets around the world. I think volatilty is driven more by the nervous trigger happy investor class and new algorithms developed in the last three years to take advantage of QE. I think any reported unforecasted change in expected GDP, employment or sentimenet from China or the US, and in some cases from Europe, will trigger big market swings.
Even though the Fed seemed to follow the broad consensus for not raising rates, to protect the global economy, the reality is that zero interest rates are hugely distorting the normal workings of the market. This is nicely captured in an opinion piece in today’s US print edition of the Wall Street Journal (see The Federal Reserve Pulls a Lucy). It is written by David Malpass, president of Encima Global LLC. He served as deputy assistant Treasury secretary in the Reagan administration. The perfect quote from the article is this:
“The theory of zero rates and giant Fed bondholdings [QE] works for government, big bond issuers and the upper crust [investor class], but it hurts lenders, savers and the broader economy.”
Thus the Fed remains between a rock and a hard place. They know they need to “normalize” rates but any effort to do so runs the risk of destabilizing the more complex economic system they have themselves help create. Efforts to protect the economy from recessions of any kind have created a system that is now so brittle, when a recession does hit, it will be nasty. If a global slowdown does take place now, the Fed has virtually no amunition to drive growth.
In fact, one wonders if the Federal Researve should wrest control of fiscal policy from the US government. If the government cannot solve problems over tax and borrowing, and that failure makes execution of moneatary policy impossible, why not manage the two together? Before central banks were indpendent politics and parties in office set fiscal and monetary policy. Due to the resulting boom and bust cycle associated with political swings that led to different models for how economies worked, it was thought that by making monetary policy independent we could eliminate the boom and bust cycle. We have not – now we have much larger boom and busts – sometimes over longer periods of time. So should we return monetary policy to politics, in order to return to smaller boom/busts, or should we have the Fed manage the entire economy?
Clearly no politician will give up the purse strings. What else will they do eery day – focus on citizen needs and improve laws? It will kill the political class – which on reflection does not sound like a bad idea. The alternative is for the Fed to get out of the way. This policy is also frightening for most folks. Worse, should one state do this it would likely struggle for a short period while other states continue their managed economic cycles. Only when related and trading nations all set their Fed’s free would markets stabilize and return to their “natural” state quickly.
As things go, the managed state we find ourselves in will persist – with the same mediocre outcomes we have been experiences. The only hope is that the invisible hand will pull through, of its own accord, and in spite of Fed and government policy. Oh well.