When does the Federal Reserve surrender?
Chair Janet Yellen said at the end of the year that the Fed was finally beginning a program of normalization of interest rates. She also said that the Fed intends to undertake open-market operations such that the Fed Funds Market Rate would trade in the range of 0.25% to 0.5%, versus 0% to 0.25% previously, what people loosely call a 25-basis-point rise in short-term interest rates.
Yellen also at least implied that the intention was to raise short rates in the same way by 25 basis points per quarter through 2016, resulting in a 1% rise in rates for the whole year. Since then at least two things have happened:
First, long Treasury yields have actually declined. The Fed doesn't control the long end of the yield curve. So, to date, the Treasury bond curve has actually flattened still further (see chart below). This is hardly what one would call normalization of rates.
Maybe the Fed should even be trying reverse quantitative easing (i.e., selling long bonds) in order to try and get yields up at the long end of the curve. The fact that the Treasury yield curve has flattened since the Monetary Policy Committee started to raise short rates is a particularly bad sign.
Flat and especially inverted curves -- though we aren't at the latter yet -- indicate that investors think that rates will actually decline, and they often presage a recession.
Second, the equity markets have become even more volatile and have effectively fallen now into a bear market funk.
This may be caused by many factors such as continuing modest U.S. growth; an equity bubble bursting; the oil shock; poor economic performance in places such as Brazil, China and Russia; negative rates now in Japan; and sluggishness in the eurozone. But there is no doubt that the very idea of these continuing rate rises through this year hasn't helped the markets one bit.
Of course, the Fed's main preoccupation is the underlying so-called "real'' economy and not the capital markets or Wall Street.
That said, if there is such carnage in the capital markets that the initial public offering market effectively closes down, as does the new-issue high-yield market, which is what has happened, this does affect the real economy. It prevents corporations from raising needed capital and thus affects investment, working capital needs and confidence in growth.
It seems to me that unless the equity market stops falling/gyrating by its own organic means, sooner or later the Fed is just going to have to call a halt to the plan. The latest indication by Yellen was that she was going to do another 25-basis-point short rate rise in the first quarter, but perhaps that will be her last move this year.
Some argue that the underlying U.S. economy with low unemployment, modest growth and a stabilized banking system is nevertheless strong enough to sustain rate rises even as the capital markets crumble. But the central problem is that the growth in the U.S. economy -- always below 3% since the end of the Great Recession and now forecast at 2.3% for this year, per The Economist's consensus forecasts -- might be better than many Organization for Economic Cooperation and Development countries, but is still fairly sluggish.
In addition, while there may be an equity market bubble, all the QE to date created absolutely no consumer inflation, contrary to many of the monetary dogmatists out there (U.S. consumer inflation in 2015 was a mere 0.1%).
In fact, global growth is weak generally, and Yellen is raising rates against the tide in other countries, i.e., other countries are seeing such limited growth that they are further loosening monetary policy. She is therefore tightening into a rising dollar, and you don't usually raise rates when your currency is appreciating.
The core of it is that the engines of new, post-industrial growth, are just not there. It won't, for example, be fracking quite yet, given how low oil prices have now fallen.
The technology revolution meanwhile never seems to make the massive impact on gross domestic product growth figures that is always expected.
No one is quite sure why. Is it because the information technology revolution is simply not as fundamental as say the invention of the automobile or trains or electricity; because it is still a revolution in its infancy; because it has created its own set of dis-economies (i.e., word processing just produces more paper work, bigger legal documents, etc.); or because some of its benefits are somehow missed from the crude GDP statistic?
It remains a mystery.
But in the absence of these new growth engines, it isn't clear we can get off the low rate drug so easily, and I suspect it will sooner or later start to tarnish former Fed Chair Ben Bernanke's reputation, just as the collapse after the Internet bubble did it for former Fed Chair Alan Greenspan. That is, Greenspan kept rates too low for long, and we see that low-rate solutions may not be real fundamental economic solutions at all; they just involve putting a lid over very hot and consistently burning coals.
Of course given that the only tool the Fed has is monetary policy, one may conclude that the Fed simply can't fix our economic "malaise" as it is really a productivity problem and not a monetary problem, hence no one at the Fed is to blame.
Well, all this might tell us that we fret too much about monetary and central bank policies anyway. Indeed, maybe they don't really set rates at all or materially affect the economy?
The underlying economy and the markets ultimately drive rates and economic direction generally and will just do what they will do. In other words, perhaps we all continue to be left in the hands of fate.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.
Jeremy Josse is the author of Dinosaur Derivatives and Other Trades, an alternative take on financial philosophy and theory (published by Wiley & Co). He is also a managing director and head of the financial institutions group at Sterne Agee CRT in New York. Josse is also a visiting researcher in finance at Sy Syms business school in New York.
The views and opinions expressed herein are those of the author and don't necessarily reflect the views of CRT Capital Group, its affiliates or its employees.