The US Federal Reserve has ended months of speculation on interest rates. In the early hours of Friday morning, the Fed decided to keep rates on hold at 0.25%.
I’ve maintained for several months the Fed had no choice in this matter. It was never going to lift rates. In the very least it’s not happening this year. Neither the US, nor the global economy, is ready for a major policy reversal.
That hasn’t stopped markets from second guessing the decision all year.
If we take the Fed at its word, it was a close call. Ultimately, it decided the timing wasn’t right. Inflation is still running below average, and economic growth prospects are slack.
Here’s what the Fed said in its official statement:
‘The unemployment rate has declined and overall labour market conditions have continued to improve.
‘Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.
‘Inflation, however, has continued to run below our longer-run objective, partly reflecting declines in energy and import prices.
‘While we still expect that the downward pressure on inflation from these factors will fade over time, recent global economic and financial developments are likely to put further downward pressure on inflation in the near term’.
Low inflation, low unemployment, and low global economic growth forecasts. That’s the gist of the Fed’s argument.
Despite lowering its outlook for the US economy, the Fed showed bias towards lifting rates. It still expects an interest rate rise at some point this year. Just as it did last month, and the month before that. And the way it’s been doing for the past 12 months.
The Fed wants everyone to think rate hikes are around the corner. Yet when it comes time for lift-off, the Fed gets bearish. Everyone’s a pawn in the Fed’s game of deception. You’d think the Fed was purposely misleading markets.
If you need any more proof, look to the bombshell Fed chairwoman Janet Yellen dropped this morning:
‘I don’t expect that we’re going to be in a path of providing additional accommodation. But if the outlook were to change in a way that most of my colleagues and I do not expect, and we found ourselves with a weak economy that needed additional stimulus, we would look at all of our available tools. And that would be something that we would evaluate in that kind of context’.
If you’re confused about what’s happening here, you’re not alone. The Fed is contradicting itself at every opportunity.
It’s clear the Fed doesn’t know what it wants. Or at least it’s not letting everyone else in on the secret.
On the one hand, it’s harping on about weak economic prospects. And in the same breath it’s telling us that rates could still rise this year.
Rates typically rise when things are going well — not the other way around. If the Fed maintains rates are heading up, it’s got a strange way of proving why they should.
The Fed is always pointing out the influence of inflation on its interest rate policy. Core inflation of 2% is generally regarded as the tipping point for a rate lift-off. But core inflation remains below this level, at 1.8%. The Fed doesn’t expect inflation to top 2% until 2018. That would suggest rates are going nowhere… for years even.
Stranger still are the Fed’s forecasts on unemployment and GDP growth.
The Fed slashed its unemployment forecasts down from 5%. It expects the jobless rate to fall to 4.8% in 2016. And it believes unemployment will hold firm at 4.8% until 2018.
Quite why it believes this is anyone’s guess. The Fed’s GDP forecasts for 2016 show a dip in real GDP growth to 2.3%. By 2017, that figure drops to 2.2%, bottoming out at 2% in 2018.
None of it adds up. The Fed’s GDP projections are falling even as it cuts unemployment rate forecasts. That means it expects improving labour conditions even amid weaker economic growth. And it assumes inflation will rise even as the economic activity drops!
But it’s possible we’re looking at this entirely wrong.
Everyone is focusing on a rate rise that may not be coming. What we should be considering instead is the opposite. Let me explain.
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Are US interest rates heading towards negative territory?
The biggest shock from the Fed’s decision was one overlooked by most people.
Take a look at the two graphs below.
[Click to enlarge]
The dot plots are future forecasts on interest rates. It’s a snapshot of where the 17 Fed policymakers, involved in setting rates, see things heading. It tells an interesting story.
For one, the general mood among Fed decision makers is becoming bearish. Across the board, you can see that rate forecasts have fallen over the next three years.
But there’s an even bigger surprise in there.
In June, not one single Fed member pegged rates falling below 0%. Most were bullish on rates rising in 2015. But the consensus has changed in the last three months.
Take a look now at the forecasts for September. Someone isn’t towing the company line.
One member forecasts rates dropping below 0% this year. Presumably that same person believes rates will remain sub-zero in 2016 too.
In light of this, I want to bring up again what Janet Yellen said this morning:
‘If the outlook was to change…and we found ourselves with a weak economy… we would look at all our available tools’.
Let that sink in for a moment.
The Fed has convinced everyone rates can only head in an upward direction. That may or may not be true. What is clear is that the Fed is open to more stimulus. Whether that comes as a result of negative interest rates, or even another round of QE stimulus, makes little difference. Why not both, even? The US economy may need it…
For now, the Fed’s decision halts talk of interest rates, at least temporarily. But the merry go round begins again soon. The next Fed meeting is in late October. After that, there’s one more meeting in mid December.
During this time the Fed’s decision will weigh on markets as it has all year, adding to volatility.
The outlook on the US economy, by Fed estimates, is weak. Global growth is slowing too. Inflation is below target. And yet we’re meant to believe rates are going up…
Don’t bet on that happening anytime soon.
Contributor, Markets and Money
PS: Like the Fed, the Reserve Bank of Australia held interest rates at 2% this month. The RBA was hoping rising US rates would push the dollar lower. It didn’t get its wish, raising the prospects for rate cuts in Australia.
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