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Weekend Reading: Fed Rate Failure

Tyler Durden's picture




 

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.  

FOMC-Forecasts-GDP-031915

"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.'

FOMC-negative

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."

Kahn-Market-091815

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.

 

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Fri, 09/18/2015 - 16:42 | 6566879 The Indelicate ...
The Indelicate Genius's picture

Why not raise a bit before christmas?

you have the cushion of the holiday debt binge but can be said to be responding to "good signs" blah blah

Fri, 09/18/2015 - 16:43 | 6566881 Hype Alert
Hype Alert's picture

Green shoots!

 

Just as the economy was getting it footing, and now this.

 

Just a blip, there will be no recession.

Fri, 09/18/2015 - 17:07 | 6566984 will ling
will ling's picture

"but, but, but larry, after 11 trillion (at least) in 7 yrs, shouldn't those shoots be redwoods by now" ?

Fri, 09/18/2015 - 16:43 | 6566884 km4
km4's picture

Speaking of failure Over 80% of Syrians believe created by US

Fri, 09/18/2015 - 17:08 | 6566986 Chuck Knoblauch
Chuck Knoblauch's picture

Get the war started.

Just do it.

Fri, 09/18/2015 - 17:18 | 6567009 gcjohns1971
gcjohns1971's picture

How few comment on the real issue.

QE is an industry.   Not just the formal QE's but the reciprocal ones in which the monetary base is systematically expanded year after year for the last 101 years.

It is easy to explain the 'slow growth' economy.

The recipients of newly printed money spend it.

Those they spend it on realign production to whatever the recipients want...recipients that can only continue to support these lines of business so long as the monetary inflation is growing.

Over time, the amount of monetary inflation needed to allow the roll-over of existing debt grows.  This requires a little explanation:

- For those who don't know, all fiat currencies are based upon debt.  One unit of currency is the Central Bank's liability.  One equally-sized unit of debt is the Central Bank's asset.

- The debt and the currency created using it as an asset are one and the same...  Except the debt bears an interest rate.   For that reason, there can never be enough money to retire the debt.  So while some debts can be paid off, the big ones, and the over-all general level of debt in any currency system cannot be paid off.  If paid off, then the currency it secures also ceases to exist.   And there is only ever enough currency to pay either the principal, or the interest, never both...because the currency and the principal are the same entity.

- The result of multiple debt roll-overs is a higher general debt level.  A higher level of debt can only be supported by a lower level of interest.

- To enable continued systematic inflation of the monetary base, debts MUST always grow. 

On with the explanation of the growth problem this creates...

So, as more and more productive capacity is devoted to servicing the recipients of monetary inflation, less and less is devoted to supporting the rest of the economy.  And changing lines of business is not instantaneous.

So...on the monetary issue...eventually the accumulated debt becomes so large that it cannot be serviced.  Then mass defaults start (2008). 

The response is to print more money. Printing more money requires more debt.  But more debt exacerbates the problem with payments...and so they can't stop for long or the conditions that caused the accelerated money printing will return.

While they accelerate, businesses serving the recipients of monetary inflation grow...   Let's call them 'inflation-service'.

For 'inflation-service' to grow, other businesses must shrink, both because they displace real assets that other businesses might use, and also because the real value derived by monetary inflation is taken from those other productive businesses, making them less productive.

So...the economy becomes a circle-jerk between monetary inflationists and those who service them.  Meanwhile the portion of the economy that services the sustainment of life shrinks.

Get it?

So why negative interest rates?

It is an attempt to get more out of the savers, while forcing them to carry more debt, so that the inflationists and inflation-servitors will be the last ones standing.  If they succeed, they only delay the day of reckoning until they have all the real value that the savers held... (which incidentally would also require the elimination of retirement, and immolation of all those whose subsistence relies on savings. No, I don't mean figuratively.  It is an old Socialist scheme 'Those who do not work will not eat.'  The unstated part is that they either had no savings or it was stolen, or some combination.)

But EITHER the monetary base must accelerate its growth until prices explode and confidence is lost in the currency OR the Central Banks and Governments ALLOW the default to happen.  The former results in hyperinflationary collapse.  The latter results in deflationary collapse. 

As time goes on, and the general debt level world-wide continues to rise, the path between those outcomes narrows.

Sometime relatively soon (days? months? a year or three?) the path between them will become INFINITELY THIN...and then the INTERNATIONAL currency system will teeter and fall one way or another.

Please note that they are perilously thin already.  The only reason it has not collapsed is that there is no real alternative, as PM's are not in enough hands yet. (but on default they will be...people will trade their jewelry for subsistence items).

Nature tends to lean towards deflation...because people choose to buy subsistence rather than service debt.

But the Central Banksters can create infinite inflation, and any loss of confidence in the currency tends to make people trade it for real things all at once.

So...no one really knows which way it will go.

But it will go...because the design of the system allows no other outcome, and no currency system sharing that design has EVER ESCAPED THOSE OUTCOMES.

Fri, 09/18/2015 - 17:14 | 6567018 Yen Cross
Yen Cross's picture

 I love the way all of the banksters and eCONomists have been bloviating [ for the last 3 years] about how China is ineffectual to U.S. growth and that the U.S. economy was magicially decoupled from the rest of the world.

 Then Moe Howard comes out yesterday and flings an EM shit sandwich in their faces. ha...fukin ha.

Fri, 09/18/2015 - 17:28 | 6567065 small_potato
small_potato's picture

Virgin Mary says major downturn to happen NEXT WEEK, while Pope is in US:

www.locutions.org

God IS watching, and speaking, and helping.

Fri, 09/18/2015 - 17:48 | 6567115 QQQBall
QQQBall's picture

right, we need easing to push more debt into the system. if everyone would just ease, we could put a MCD on every other corner and Burger Kings in between.

 

We need to unwind the leverage, not provide greater leverage. ...we pulled bemand forward with cheap debt and weak lending standards and so according to Ray, we just need to ease some more. It started with the Nasty DotCom Bubble, Y2K liquidity flood, then shifted to a housing bubble, EM bubble and now we just need to blow harder.The fucking liquidity and low rates caused this - put Ray on the short bus with Krugman and Summers.

 

I'm right - ray is wrong. Savers and prudent investors are being destroyed. When you were a kid - did you hear of Reverse Mortgages?

Fri, 09/18/2015 - 20:04 | 6567523 Montani Semper ...
Montani Semper Liberi's picture

 The only time I saw Robert Wagner on tv when I was a kid, was in the late 60's when we all had to watch one of dads' favorite shows, "It Takes A Thief".

 Oh, the irony!

Fri, 09/18/2015 - 18:58 | 6567325 TuPhat
TuPhat's picture

The economy cannot improve with rates at 0.  There is no incentive to save and create capital to invest.  There is no incentive to invest in plants and equipment when zero interest rates encourages financialization and stock buying.  The stock market does not make anyone wealthy until they cash out.  They won't cash out as long as they think the Fed will keep pumping it up.  There is no way we can go anywhere but down from here.  The Fed knows this.  The plan is to suck all the wealth out of the middle class and retirement plans and then crash it and use that wealth at the fire sale to buy up everything that's left.  They stay in control that way.  Higher interest rates would empower savers and retirees.  Retirees make up an ever increasing proportion of the population.  In a consumer based economy when denying the largest demographic the income to spend it can't help but have a bad effect.  That is exactly what the Fed wants.  I don't believe they don't know what they are doing.  They know.  And they are getting what they want.  Defend yourselves.

Fri, 09/18/2015 - 20:13 | 6567554 sheikurbootie
sheikurbootie's picture

Who the fuck keeps thinking the Fed is going to raise rates?  STOP IT!  Jim Sinclair has been saying this and explaining this for 8 years.  If the Fed raises the rates an immediate and unrecoverable crash will occur in the new age retirement vehicle (401k, stock market).  Close your eyes and imagine the anger from 100-200 million Americans will near $0 for retirement.  That won't end well.  It's QE to infinity.  THERE IS NO OTHER OPTION.

Sat, 09/19/2015 - 07:36 | 6568631 Last of the Mid...
Last of the Middle Class's picture

Biggest head fake I've seen so far. Someone (read banker) finnally got to the dusty old snatch and told her it won't work. Stay tuned for the next head fake. . . er I mean meeting.

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