If the Fed Follows the Market, Why Won't Rates Go Negative?

Mish

The Market pared back bets on negative interest rates but questions still persist.

A chicken and egg scenario involving the Fed has emerged. Who is following whom?

Traders Trim Bets

https://twitter.com/throughnothing/status/1260668753303539715?s=20

Does the Fed Follow the Markets?

It appears that way, but if all the Fed does is follow the markets, why do we need the Fed at all? 

Fed Uncertainty Theory

I discussed the above question in detail, on April 3, 2008, before the collapse of Lehman in the Fed Uncertainty Principle.

It is still one of my favorite posts. Here are the key ideas.

The Observer Affects The Observed

Most think the Fed follows market expectations.

However, this creates what would appear at first glance to be a major paradox: If the Fed is simply following market expectations, can the Fed be to blame for the consequences? More pointedly, why isn’t the market to blame if the Fed is simply following market expectations?This is a very interesting theoretical question. 

While it’s true the Fed typically only does what is expected, those expectations become distorted over time by observations of Fed actions.

I liken this to Heisenberg’s Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.

Fed Uncertainty Basic Principle:
The fed, by its very existence, has completely distorted the market via self-reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed’s actions. There would not be a Fed in a free market, and by implication, there would not be observer/participant feedback loops either.

Corollary Number One:
The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn’t know (much more than it wants to admit), particularly in times of economic stress.

Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.

Corollary Number Three:
Don’t expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.

Corollary Number Four:
The Fed does not care whether its actions are illegal or not. The Fed is operating under the principle that it’s easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.

Negative Rates?

No, the Fed may not know much but it has observed that negative rates did not help either Europe of Japan.

It's easier to see someone else's mistakes than your own. 

Fed Beholden to Banks

And whereas the ECB punished European banks by charging interest on excess reserves, the Fed paid the banks money effectively bailing them out over time. 

Given the Fed is beholden to the banks,the Fed will not set rates in negative territory although it may be possible for rates to go a few basis points negative for technical reasons. 

Why Are We In This Mess?

In regards to corollary number 1, we are in this mess because once again the Fed held rates too low, too long blowing another huge asset bubble in the wake. 

There Are No Temporary Measures, Just Permanent Lies

In regards to corollary 4, the Fed announced that it will buy junk bonds. This exceeds its legal authority, adding to illegal actions it took fighting the Great Recession.

Supposedly, junk bond buying is temporary.

But as I pointed out, There Are No Temporary Measures, Just Permanent Lies

Gold vs Faith in Central Banks

Gold vs Faith in Central Banks4

Buy Gold

Stephanie Pomboy, President-Meridian Macro Research, summed things up nicely in two short sentences.

"The Fed is clueless. Not like a little clueless...like A LOT clueless "

"Buy Gold"

Mish

Comments (48)
No. 1-20
tokidoki
tokidoki

The Fed has a super high batting percentage when it comes to making markets go higher. Clueless? Only for people who are short.

Also no one can stop the Fed.

Jdog1
Jdog1

The Fed's purpose it to keep banks in charge of the country. What they do they do for the best interest of the banks, and not the public.
We will never be a free or prosperous until the Fed is abolished.

bubblelife
bubblelife

Now, say my name
....Heisenberg
You're goddamn right

Tony Bennett
Tony Bennett

"No, the Fed may not know much but it has observed that negative rates did not help either Europe of Japan.

It's easier to see someone else's mistakes than your own. "

...

Yes ... and, So?

I've mentioned this before, but when Larry Summers was assistant Sec of Treasury under Clinton he gave a speech castigating Japan for zombifying its economy to protect its banks ... and how US banks were the envy of the world with reserves / regulations. Fast forward to 2009 ... Summers all for protecting banks with TARP + FASB 157 (move to mark to model).

Funny how things change when shoe on other foot.

Rates will go lower as look upon as best of bad choices ... and, of course, Mr Stock Market will want it to fuel its TINA image.

RonJ
RonJ

"The Fed will be disingenuous about what it knows"

The FED has always been fearful of an audit.

aqualech
aqualech

The Fed is actually private and owned by the banks in their regions, unlike most other central banks like BOJ and ECB. Negative rates are horrible for bank profitability and share prices, and bank share prices matter a lot to the US Fed. Therefore, no negative rates. The ECB doesn't care much about European bank share prices.

Tony Bennett
Tony Bennett

"Given the Fed is beholden to the banks,the Fed will not set rates in negative territory although it may be possible for rates to go a few basis points negative for technical reasons. "

...

Sort of pregnant? Negative still negative. You are probably correct in that FR won't set a negative rate, but never a basis for my negative yield call. Instead $US denominated assets will be target for carry trade. King Dollar + treasuries with positive yield will be enticing for many foreign investors ... considering the alternatives.

Casual_Observer
Casual_Observer

what kind of currency does it take to buy gold or other "precious" metals or commodities ?

AWC
AWC

The Fed is following the market? The Fed is the market. And if the Fed falls behind in it’s “Money Printer go Brrrr” policy, it will simply close the markets until it catches up.

Don’t believe for a nanosecond that these “markets” would be anywhere near half present levels, sans all-in Fed manipulation. Hell, they’re even buying junk, for cricks sake.

Casual_Observer
Casual_Observer

We may not like it but the Fed is the lender of last resort and they are backed by the Treasury. They won't go negative but 0% is an option until the economy starts recovering. Banks cannot be profit centers in a depression-scenario but the banking system is backed by the Fed. We have MMT by another name.

Casual_Observer
Casual_Observer

"Only a free market does"

-

Intervention is part of a free market.

Maximus_Minimus
Maximus_Minimus

We're in this mess because the central banks (i.e. the committee of wise men) should never have been allowed to set interest rates. The demand for credit should guide interest rates. If it goes baloney, so should the interest rates; not print more money to keep to a target rate.
The rest is the compound interest on a stupid idea.

FromBrussels
FromBrussels

Now that the FED has opened the free money floodgates for once and for ever, they should also send a couple of trillion dollars to South America, so people can live happily without even coming to the US in search of the American Dream ....hahhahaha ....we re on the road to nowhere (to the cliffs rather ) but we don't care ! GOOD LUCK to everone ....and myself in particular !

elvis07
elvis07

Buy gold, 40 years ago gold hit 850oz. an investment in long term zero coupon treasuries beginning in 1982 and with a long duration maintained returned 12 pct compounded over that period making that 850 worth $60,000 today. Gold at 1700 has doubled in 40 years. 1.8pct compounded. Every dog has its day.

Six000mileyear
Six000mileyear

The FED's partner in crime is the FDIC. Both created the moral hazards necessary for banks to take excessive risks with people's savings, while discouraging depositors from holding banks accountable by choosing to hold cash/gold instead of lending to banks. The government reinforced the moral hazard by passing laws restricting how much cash may be deposited or withdrawn at any one time.

elvis07
elvis07

In June 1981. Merrill Lynch made one of the greatest market calls in history. Full page ads in all major publications. The title read "Bonds, dawn of a new bull market" i was a broker at Merrill then and took that market call to heart.

Tony Bennett
Tony Bennett

Well, well, well .....

Goldman Sachs' Hatzius on why he's not ruling out negative interest rates
Jan Hatzius, Goldman Sachs chief economist, joins 'Closing Bell' to discuss why he still thinks the Fed could use negative interest rates to help the economy and whether the U.S. could recover in the second half of 2020.

JonSellers
JonSellers

In a deflationary environment, the Fed has to follow the market to lower interest rates. Nobody is taking out loans at high interest rates. In a deflationary environment, you have no confidence that you won't have to cut prices which will pressure your ability to make loan payments. Having high interest loans is insanity.

In an inflationary environment, the opposite is true. The point is, the Fed doesn't set interest rates. It manages them within the prevailing winds of the economy. The Market sets interest rates, and those rates are low. Due to deflation. The Fed is just stabilizing the amount of liquidity needed for the markets to function effectively, at whatever interest rate the market finds acceptable.

Jdog1
Jdog1

Is there anyone who really thinks in the real bond market that someone would pay you to borrow money from them? Especially considering you probably will not be able to repay the loan????

CA2020
CA2020

Negative interest rates will cause trillions of dollars to try to move somewhere, it would be very ugly in my opinion.


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