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Ready for Anything! (?)

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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?

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Not so Fast …

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It’s been week since a blowout jobs report set fire to financial markets and signaled that everything is about to change. Barataria predicted a good report, if very timidly, and gave everything a week to shake out. So where do we stand a week from the first clear signal liftoff is occurring?

The short answer is that markets have absorbed the reality of a rising Fed Funds Rate. The long answer is that it sure doesn’t look like it for a lot of reasons which are complicated and confusing. In an increasingly smaller world there is nothing that confines money to one “market”, meaning that pressure is on from all directions.

The upshot is that after an initial spike there is reason to believe a rise in interest rates by the Fed may yet trigger a net medium-term fall in interest rates paid by consumers, as predicted. It’s worth explaining further.

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Ready for Liftoff?

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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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The Case for Raising

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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

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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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