Fed Raises Rates to Cut Them Again

As news filtered through of the Federal Reserve’s first rate hike in nine years, optimism swept through the markets. Traders went on a buying spree. The Dow Jones finished 1.3% higher by close of trade. The S&P500 was up too, gaining 1.5% on the day.

The US dollar weakened slightly on the announcement, before rebounding. But the effect on the Aussie dollar was miniscule. Early this morning the Aussie was buying 72.25 cents.

With unemployment at 5.5%, markets were quick to proclaim the US economy had turned a corner. This, supposedly, was enough to justify a rate hike.

Before anyone comes to any conclusion about what all this means, it’s worth bearing a few things in mind.

First, the Fed’s hike leaves US rates sitting at between 0.5%, up from 0.25%. If it wasn’t at zero, that’s seem really low because, well…it is really low. A measly 0.25% rate hike doesn’t tell us anything in truth.

At a minimum, it’s not at the level where we can announce the death of cheap credit just yet. Credit remains easy for anyone that wants it.

Secondly, we have no idea how gradual this ‘reversal’ will end up. Or if it ends up lasting for that matter. Take a look at the graph below. As early as next month, markets expect a rate cut…

If this is a sign of the ‘lift off’ we’ve been waiting for, it’ll crash before it ever leaves the ground.

fed rate chance

Source: Zerohedge

Of course, we can always take the Fed on its word.

Over the next 12 months, it’s expected that we’ll see a further four rate hikes. That would leave the official cash rate at 1.4%. To put that figure in perspective, it’d still rank below Australia’s current record low 2% rate.

And that assumes the Fed doesn’t change its mind in due course. For a central bank that’s been promising rate hikes all year, and only just delivered, take anything it says with a pinch of salt.

Inflation target could dampen further rate hikes

The Fed noted in its official statement that it expects inflation to rise in the medium term. Quite why it believes this is anyone’s guess.

Interest rates and inflation have an inverse relationship. When rates go down, inflation tends to rise. That’s because it promotes borrowing. That, in turn, boosts spending activity, helping to push up inflation.

The opposite is true when interest rates rise. As rates trend up, borrowing levels cool, hurting consumption.

In light of this simple logic, how does the Fed hope to reach its 2% inflation target? And that’s before we take into account the Fed’s own forecast readjustment. It just lowered its 2016 inflation forecast down 0.1% to 1.6%. And inflation is meant to go up? The Fed’s definition of medium term must stretch into 2018…

So what’s the Fed’s getting at?

In theory, it’s leaning on lower unemployment pushing up spending. Should spending rise, inflation would edge up too. Yet even with a ‘stronger’ jobs market, retail spending has been weak recently. Consumption rose just 0.1% during October. Despite the fact that wages grew 0.4% during the same month.

So US consumers aren’t binging on goods, as one might be led to believe. Even with low oil prices, consumers are stashing their money instead of spending it.

Its left experts feeling slightly confused. Why aren’t consumers consuming? If the jobs market is so great, shouldn’t that reflect in better than expected retail numbers?

Maybe the answer is simpler than we give it credit for. Maybe everything isn’t wonderful. Maybe the jobs market figures are misleading. Maybe 30 hours, as US lawmakers define full time work, isn’t enough after all? Maybe it’s all this and more.

Regardless, the Fed will have trouble reaching its inflation target. Reining in credit typically doesn’t help lift inflation. Why it’d be any different this time around is anyone’s guess.

More Fed rate hikes? No, QE for everyone!

For now, we shouldn’t put too much emphasis on this rate hike.

Remember, interest rates are just one lever of central banking monetary policy. What the Fed hasn’t, and won’t, rule out is the possibility of QE.

Short for quantitative easing, QE is what happens when interest rate policy stops working. It sidesteps the whole charade of pretending there needs to be order to money creation. Instead, QE dumps money on the economy, even if no one asked for it.

Yet the difference between interest rates and QE is academic. Both enable cheap credit to flourish. Higher rates count for little if it ultimately leads to more QE.

Many people are in the mindset the era of easy credit is coming to an end. They see the Fed hike rates for the first time in a decade, and assume it’s become ‘policy’. But a policy, of any kind, is an ongoing strategy with an endgame. The Fed doesn’t have that. It’s making things up as it goes along.

However, let’s assume the Fed isn’t pulling your leg. Let’s say that US rates hit 1.4% in 2016. What would that mean?

If nothing else, it would add further doubt to a sluggish global economy.

US capital has driven global growth for decades. Higher rates of return in developing markets has become an attractive destination for US capital.

Should rates continue climbing, emerging markets will feel it the most. And the US won’t care. Not really, anyway. The US can afford to let global growth sag even further. Despite its position in global finance, the US economy remains insular. It doesn’t rely on exports to drive its prosperity. Domestic consumption is the bread and butter of the US economy.

Maybe that’s the endgame though. Maybe the Fed is purposely fuelling a larger crash in the global economy. You can feel it. We all can. There is an underlying sickness in the global economy.

On top of which, there is a US$70 trillion derivatives bubble simmering in the background. One that’s waiting to pop at the right time. Maybe the Fed’s move is the tipping point that unleashes a market crash that will make 2008 look like child’s play.

Or maybe the Fed is just lifting rates to lower them again.

We’re either at the end of the credit boom, or at the start of a new one. Your guess is as good as mine.

Mat Spasic,

Junior Analyst, Markets and Money

PS: Aussie interest rates, at 2%, are likely to stay at record lows according to Markets and Money’s Phillip J. Anderson. He went against the mainstream, arguing that interest rates would remain low for decades…even as economists were predicting rate hikes.

Phil’s new report, ‘Why Interest Rates Could Stay Low for the 21st Century’, is a timely reminder of what the future holds. In the report, he warns that you won’t be able to count on your savings to fund your retirement. Inflation, stemming from low rates, will only eat into your reserves.

But there are ways you can benefit from this…provided you act now. Phil wants to show you the best way to invest in this low rate environment. That’s why he’s prepared a four-step strategy to help you boost your portfolio. You’ll learn exactly where to park your cash over the coming decades. And how this could help grow your wealth over time. To download the report, click here.

Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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