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Three Reasons the Fed Cannot Let Rates Normalize
Analysts and commentators remain hung up on whether or not the Fed will raise rates next week.
Certain Fed officials have been stating that the Fed should commence tightening. However, with China’s bubble collapsing, dragging down the Emerging Markets, there are plenty of excuses for the Fed to postpone yet again.
Ultimately, I remain convinced that whenever the Fed does hike rates, it will largely be a symbolic rate hike, say to 0.35% or 0.5%. That will be it for some time.
I say this because the Fed cannot afford raising rates anywhere near historical norms (4%). There are three reasons for this:
1) The $9 trillion US Dollar carry trade
2) The $156 trillion in interest-rate based derivatives sitting on the big banks’ balance sheets.
3) The weak US economy cannot handle rate normalization
Regarding #1, there are over $9 trillion in borrowed US Dollars floating around the financial system invested in various assets. When you borrow in US Dollars you are effectively shorting US Dollars. So if the US Dollar strengthens, you very quickly blow up (carry trades only work when the currency you are borrowing in remains weak or stable).
The US Dollar has rallied over 20% in the last year. It is currently consolidating. But if the Fed were to raise rates significantly, the interest rate differential between the US Dollar and other major currencies (the Yen is at zero, while the Euro is negative) would result in large amounts of capital moving out of the Yen and Euro and into the US Dollar. This would blow up that $9 trillion carry trade leading to systemic risk.
Regarding #2, bonds are the senior most collateral backstopping the derivatives markets. Over 77% of derivatives are based on interest rates. This comes to roughly $156 trillion in interest rate-based derivatives… sitting on the big banks’ balance sheets.
If even 0.1% of this money is “at risk” it would wipe out 10% of the big banks equity. If 1% were “at risk” it would wipe out ALL of the big banks’ equity.
Suffice to say, the Fed cannot afford a spike in interest rates without imploding the big banks: the very banks it has spent trillions of Dollars propping up.
Finally, the US economy cannot handle a normalization interest rates.
This is not the usual “the Fed cannot raise rates ever” nonsense. It is more a structural argument. A sharp drop in business investment is what causes recessions. When businesses stop investing, job growth slows and the layoffs start soon after. This is how a recession begins.
With corporate profits already falling, US corporations already have less cash available to pay off the gargantuan debt loads they’ve accrued in the last six years (courtesy of the Fed keeping rates at zero). A spike in rates would only accelerate the pace at which corporations cut back on investment, as they have to spend more money on debt payments. This in turn would trigger a recession.
At the end of the day, the Fed has failed to implement any meaningful reform. The very issues that caused the 2008 Crisis (excessive debt, particularly in the opaque derivatives markets) are at even worse levels than they were in 2008.
Another Crisis is coming. Smart investors are preparing now.
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5 basis points.
Here is one you can't blame on Bush....
Death of the Pacific Ocean.
Instead of MSM covering this world changing event, last week they give airtime to "Big Blue" from like 2006 which portends to show an ocean vibrant with life.
Instead reality is the Pacific is dying, mass animal deaths, even NOAA declaring an UME Unusual Mortality Event. Attacked from several directions, with Fukushima as the last straw.
Here is 61 pages of links to articles that show the progression of this disaster since 2011.
Spread the word. Its time to wake up, or else its "wake up, time to die"
http://nukeprofessional.blogspot.com/2015/09/61-pages-of-stories-of-deat...
The Federal Reserve has failed to take serious efforts in pushing the government to take the necessary reforms needed to move the economy forward. Policy makers aided by the media thrive at presenting simplistic answers that solve both economic and society’s problems with little or no effort required from the masses. What started as a program to support and prop up both derivatives and the economy has morphed into the main driver of economic data.
Between the low interest rates that has propelled investors into high risk assets in search of a positive return on their money, and money being pumped into the system, the markets have become distorted and disconnected from the economy. The idea that investors will continue to pour money into the sky high equity market is flawed. More on why an exit strategy from easy money remains elusive in the article below.
http://brucewilds.blogspot.com/2014/06/exit-strategy-from-qe-remains-elusive.html
They will raise rates somew token amount just so they can say that they are testing the waters to see how sound the economy is. One month later they will use the negative impact on the numbers to use as justification to continue QEinfinity which is their ultimate objective. They just have to rationalize it the way a junkie will justify "just one more" each and every time . . .
I agree that they will probably raise rates 0.25 or 0.5% and then hold it there for a long time. I've also heard some pundits suggest raising a measly 1/8%, in which case they could afford to do the same miniscule rate hikes several times (with great fanfare each time) and it still would be low enough to not matter.
Another important reason why they can't raise rates is because it would blow the federal budget out of the water. Reps and Dems already have trouble coming to agreement, but if the interest expense explodes then it would be far harder. If rates on T-bonds go up then the budget deficit goes way up and we could soon face our own Greek moment where we can't borrow to cover it.
This author is a retard. Corporate stock buy backs at 0.25% and there stocks go 200%. What does he mean companies can't afford it. Do the math.
Thanks captain obvious!!!
Expect the Fed to attempt a rise; they HAVE to.
100bps or less, yes, but there will be something.
They simply have NO choice anymore.
m
Totally agree. Janet knows she waited too long to raise them and now must do it. Even if they only raise it 50bps, they can at least say they can do something when the next recession officially starts. She also has cover by raising so little because she'll at least have the excuse that if such a small raise had disasterous consequences, then the economy was far weaker than anyone knew.
not necessarily. In a battle of attrition one option is to do nothing and let your opponents fall apart faster than you... ...look at Brazil...
"Three Reasons the Fed Cannot Let Rates Normalize"
What makes you think that, in the end, they will have any choice? You can toss the market artificially to the skies. But sooner or later (usually this), it will fall back down to it's natural level (after a bit of overshoot).
It comes down to what the mega-banks want and a rate rise ain't it......
All the money the Fed lends banks goes to speculation. The money it lends to goverment is mostly used for militarism and cronyism. The money stagnates and is decoupled from the underlying economy. Raising interest rates in this environment makes no difference whatsoever.
I'm looking at the post-WWII devaluation as the best model.
Get good assets.
Don't forget the Federal budget deficit. A move in the 10 year from 2% to a more normal 5% would result in additional interest payments of $540 billion. The U.S. Would be back to trillion dollar annual deficits.
Think old farts. Old farts and entitlements. We can never afford interest rate hikes due to Social Security, Medicaid and Medicare and V.A. benefits, just to name a few, if interest rates went up and so did cost of living rate adjusted payouts.
Corp./Gov. has already for years been using hedonics to head fake inflation and C.O.L.A. A rate hike just blows that out of the water. Then the old farts and the Free Shit Army start agitating for political change and the Poltrixsters in D.C, can't go for that and trillion dollar deficits will be the order of the day.
That is....publically ADMITTED trillion dollar deficits. We already have those. It's just off budget, off the books.
Yep.
There are so many ways for this to go up in smoke, it's hard to keep track of 'em.
m
Unless the Fed keeps its balance sheet bloated and keeps giving the interest right back to the Treasury.
I don't think a lot of people realize that the deficit is artificially depressed by the Fed handing the interest on $4.5 trillion right back to the Treasury.
Yeah. Silly me.....thinking the accounting would be legit. What was I thinking?