WHY FED APPEARS CONFUSED?

It is not known to men what is good for them. I read that lines in school in my English textbook. I keep remembering that sentence every now and then. The Fed appears to have me recollect it.

Since last many months we are hearing that Fed will hike interest rate 5 times while others say 7 times and we dont see end to this speculation. Today in this blog we will discuss about the same with justification.

A firm reminder that Fed has only talked about increasing the rates. It hasn’t even stopped the bond buying program and yet the markets are already telling them to stop. Well, if you are in control, you must be able to manage the markets rather than markets managing you. It’s the tail wagging the dog. It won’t take long for the fed to reverse its position if the market were to continue its decline. the markets performance during the 2018 end isn’t so distant a memory to remind the readers what happened then.

While the pandemic had its own requirement of fiscal stimulus, it also aided the monetary policy efforts in bringing the markets back on track. Since it was repeated on a global level so the effect was unprecedented. It took more than 20 trillion dollars for the global economy to recover. Yet the global GDP is still 94 trillion dollars in 2021 hardly 8% up from 2019 before the pandemic struck.

Not a record you would like to show someone for all the money thrown at the problem.

The IMF predicts 4.9% world GDP growth. To have such a positive outlook towards global GDP would mean that the world economy should mean we have fought the pandemic well. That employment numbers are already in the 90 percentile and wage growth happening would mean a clear sign of overheating markets. Yet the Fed has to manage the expectations of the market. It has to be seen in control of the market and yet it has to raise the rates to manage the small window it has been left with given that it is already behind the curve and the yield curves at the long end are inverted indicating recession.

 One wonders how this conflicting roles can be carried out. For if the Fed were to raise rates one wonders if the wealth effect created during the past two years of extra ordinary money printing will sustain. The other thing to consider is how fast will the Fed fold if the rates were to rise. The Fed is already at the point where it will stop bond buying.  The 60 -40 portfolio is hammered as both bonds and stocks are going down.

Real yields globally are up and putting pressure on the bond markets. The total quantum of negative yielding debt is now cut in half.

Treasury Real Yield Curve Rates

And there is no stopping the debt train as it reached another landmark with USA debt now crossing 30 trillion mark with only 45 days gone in the new year.

Yet when the Fed tells us that they are planning to raise rates four times we might be forced to think that the fed will fold midway.

Conclusion

That fiscal policy has helped people purchase goods and services while been in pandemic is well known. But to believe that the same policy measures can be repeated again would be fallacy. As the debt increases its utility to generate GDP reduces and more and more debt goes in servicing the interest. This is already shown below.

The other thing to note is that during every recession the federal rates have come down. It is now at zero.

If the fed doesn’t raise rates now it won’t have anything to cut during recession. The experience from the euro zone regarding negative interest rates haven’t been kind enough to think of going negative. Which means there is hardly any room left for the Fed to navigate. Keep buying the bonds and provide liquidity just to taper over the problems. That’s the job left. Quite a boring job without much limelight.

The Fed will definitely have to raise rates. That it would be able to get out of the year with 4 will be a great achievement. But it won’t be long when interest rates will reach zero again. One wonders what will be used to drive the next stimulus then?

Is it War?

  • By Nishant Maheshwari and Vishal Vora

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