Ready for Liftoff?

Another first Friday of the month, another jobs report. By the time you read this the Bureau of Labor Statistics’ (BLS) monthly Employment Situation Summary for October may have been released diligently at 8:30AM Eastern Time on the appointed date. The stock market may be reacting and everyone will turn their attention to the Federal Reserve.

It’s a strange ritual which keeps financial writers busy. But does it mean anything?

If all goes as it should this one should really move the markets. Exactly which direction is hard to tell for a variety of reasons – but that is what will matter more than anything else if this report comes in as “good” (in quotes) as it should be.

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Good News! It’s Good News.

Before we can call the economy “good”, we have to be in a situation where good news is taken as unvarnished good news. And that seems to have finally happened.

Janet Yellen outlined in great detail exactly why interest rates not only have to start rising by the end of the year, but why they have to go up to around 2% before the Fed is done. The market responded positively, getting another shot of good news this morning. Has the monkey of cheap money finally been scraped off their backs?

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The Case for Raising

17 September is the date. We find out then, at the end of the Federal Reserve Open Market Committee (FOMC) meeting, whether or not the benchmark Fed Funds Rate is raised. Nearly everyone agrees that it’s likely to happen, either in September or in December. But trillions of dollars will be riding on the moment when the press release is issued on the Fed’s website telling people what exactly is happening.

Except for one thing – we won’t know exactly what will happen because the stock and bond markets may react in odd ways that are not easily predicted. The same is true for currency traders.

What it all comes down to is whether or not the FOMC thinks it is a good time to start or not. The arguments for and against are fairly easily summarized, but to Barataria the case is strong for a rise – especially if the net medium-term effect is that consumer rates go down.

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From Net Collector to Payer

We’ve discussed many times before how the Federal Reserve sets the interest rates for everything from used car loans to mortgages to savings accounts across the US. The task has always fallen to the Federal Reserve Open Market Committee (FOMC) and its “Fed Funds Rate”. As far as anyone can tell they perform a calculation based on the prevailing conditions as to what the optimal rate should be. They balance out the need for more jobs (favored by cheap money, or low rates) with a desire to keep inflation in check (with high rates) and a rate is published. From that baseline for the cost of no-risk money a premium is added by a bank based on the risk (low for a mortgage, high for a used car) or subtracted (the value of savings) and all is good.

Except for one small detail – that mechanism has been horribly broken since 2008 when every calculation suggested the optimal rate was below zero. As long as rates are near zero and there’s a flood of cash in the financial world (not that you are getting any) we have what’s known as a “liquidity trap”. And the way interest rates are going to be set in the near future is going to turn on some far more obscure things such as the “Reverse Repo Rate”.

Yes, it’s complicated.

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Fed Funds Future Foggy, Fudgy

The stock market is surging on solid corporate profits. Jobs are being created, if a bit slowly. Should the Federal Reserve continue its policy of Quantitative Easing? The short answer is probably not. But the policy of buying $85B in mortgage backed securities is continuing, at least for the foreseeable future. And with Janet Yellen, the Fed Vice Chair, slated to replace Ben Bernanke in January we have every reason to believe that the policy will continue.

It’s time to examine how the Fed sets their benchmark interest rate, the Fed Funds Rate, and what we can reasonable expect them to do with it in the near future. It shows just how much the Fed is really in charge of the economy – absent a Federal Government that is doing what needs to be done.

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