In a speech to the Economic Club of New York the most powerful person in the world, elections be damned, called back the need for continuing “ramp up” in the Fed Funds Rate. The stock market rallied as the happy days of last year returned and everyone had reason to believe that free money was on the horizon.
Funny, they don’t cheer like that for Bernie Sanders.
What is going on? Are we not going to raise rates this year after all? Has Yellen started channeling her inner Greenspan by saying as little as possible in the maximum number of words?
No, this is what we have to expect. It’s really all about China, which is to say all about currency conversion, and the much-hyped “dual mandate” of the Fed that’s really a much more complex triple mandate or more. And we all, sadly, have to stay tuned to find out what it really means.
By the time you read this, the Fed Open Market Committee (FOMC) has probably raised their benchmark Fed Funds rate and given guidance for the next few years. More importantly, everyone has freaked out one way or the other and the stock and bond markets have probably done something that has everyone puzzled.
We still live in a financial world that defies expectations. It has to be “experienced”, just like the various things you did in your mis-spent youth that built “character”. The question becomes – what great wisdom are we learning from all of this?
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?
The forecast calls for the cold and stormy June to resume here in the middle of this vast continent after a brief heat wave. We’ve come to rely on weather forecasters to at least give us a guess as to what it will be like as the lazy days demand outdoor fun. Tomorrow night, for example, they tell us there is a 25% chance of rain.
But such forecasts are usually limited to the weather. Why not stocks?
The short answer is that when there’s a lot of money riding on something a busted forecast could be cause for a lawsuit. No one wants to stick their neck out too far beyond the herd because anything unprecedented is a risk not worth taking. But we’re here among friends, right? Barataria makes forecasts from time to time and this month is a good one for it. The reason is that we can see a storm brewing as stocks have gotten pretty far ahead of the “recovery” so far.
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”.