Communication breakdown, it’s always the same
Communication breakdown, it drives me insane

~ Led Zeppelin I

Are you confused about the Fed’s actions? Weren’t they supposed to hike rates in early 2015, then late 2015, now mid-2016 or maybe not at all? What is the logic behind this constant flip-flopping? What does it mean for your practice? Let’s attempt to answer those questions.

Call Me The Maestro
Do you remember Alan Greenspan, the Maestro? The man who so mastered the skill to speak for hours while appearing to earnestly answer questions, but who rarely gave away any substance. All that ambiguity was supposed to have been eliminated as the Fed planned to provide clear guidance for the markets—a new, open Fed of Ben Bernanke and Janet Yellen. But as of late, market participants are more and more confused about the Fed’s future actions and, more importantly, the logic behind them. Promised hikes never materialized and now there is talk of not hiking until mid-2016 or even later. Market participants are completely confused. Look at results of the RBS survey in the picture below. RBS asked its institutional clients two questions:

Question 1: Is volatility going to continue increasing?

Question 2: How do you account for the Fed’s actions when creating plans for your clients?



 
It is clear that most ‘smart money’ thinks the Fed is drifting rudderless and is possibly clueless. The chart above is extremely scary, and there are two reasons why.

Reason #1: Fed Is The (In)visible Hand
The Fed controls financial markets in a way that’s bigger than ever before. It owns a great deal of high quality collateral (Treasuries) that is needed to enable vast amounts of financial transactions. Zero interest rates drive corporate borrowing which in turn drives record issues of corporate debt and stock buybacks that move the markets higher. When buybacks stop, huge amount of money will disappear from the equity markets. The Fed practically owns the housing market through securitized debt instruments.

Reason #2: It Is A Confidence Game
Central banks depend on credibility. The Fed had such significant impact on the markets during the tenures of Greenspan, Bernanke and Yellen because of credibility that was established by Paul Volcker. Without that credibility, its rate-setting abilities would have been far less effective. When Volcker raised short-term rates to 17 percent to stamp out inflation in the early 1980s and stuck to his guns in the face of a recession, that persistence established a level of credibility that the Fed has enjoyed ever since. Now it appears that the credibility is gone.

First « 1 2 3 » Next