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The Fed’s Market Disruption

December 17, 2015

Yesterday, the Federal Reserve announced a 25 basis point increase (0.25%) in interest rates.  They did this at 2:00 pm, a time when corporations are precluded from announcing their earnings so as to not disrupt the market.  Yet, the Fed makes its important announcements at a time that is likely to cause the most disruption.  Why?

Perhaps what the Fed does is not that important in substance and the self-created media supported drama imagines an importance.  Let’s look at some facts:

  • The increase of 0.25 percent will have no substantive effect on anything.  Savings rates will not increase, corporate borrowing rates will not increase, the Treasury borrowing rates will likely not increase, credit card interest rates will not change, borrowing for major construction certainly will not change and home mortgage rates will not increase on any sustained basis
  • Even assuming the increase will have an effect, we are talking about one quarter of 1 percent.  (Nothing meaningful to anything of any importance…)
  • The increase is used as a signal that the Fed believes the economy is getting stronger.  It seems that the same signal could have been given by a press release with the attention paid to that being about the same as to the 2:00pm announcement – nothing
  • The media hypes the Fed’s actions so there is a reaction most notably in the stock market but most of that is smoke and mirrors and the reactive changes will dissipate days later
  • The Fed has some sway and control over short term rates but no influence on long term rates and their belief in their long term influence is very disappointing to me
  • The Fed believes they control long term rates though their maneuver known as Quantitative Easing where it bought up billions of dollars of home mortgages, but there is no evidence this created any meaningful benefit
  • The reality is that long-term interest rates are a reflection of the demand for long term funds
  • Borrowing is done for long term periods to finance investments in major projects with the anticipation of a positive return on investment (ROI), i.e. growth is anticipated and expected
  • In spite of low borrowing rates, many long-term construction projects were not initiated by businesses but, rather, by not-for-profits and colleges who did not have to be concerned with the ROI as long as they could expect contributors and rising tuition to cover the debt service
  • Today’s long-term borrowing levels are still at record lows signaling a clear indication of the expectation of slow growth, low inflation, and an inability to earn a reasonable ROI which is virtually nonexistent at this time either in the U.S. or worldwide.  There is no borrowing and the Fed’s rate increase cannot and will not affect this.  Only the expectation and anticipation of growth will
  • Big data indicates lowering unemployment in the U.S. and that is so.  However, what is not measured is the number of people that are underemployed or who have taken themselves out of the search for employment.  That is a drag on our economy and the “strengthening” economy the Fed provides as its reason for the increase is based on an illusory statistic
  • The purpose of the Fed is to try to periodically rebalance the economy by moving short term rates up or down. In recessionary times it would reduce rates to encourage spending, borrowing and investing to create employment.  During expansionary times it would raise rates to restrain spending, borrowing, investing and job creation in order to hold back inflation.  In the 2008/2009 financial crisis period it also started buying bonds and mortgages in an effort to keep rates down
  • Everything an organization with the influence of the Fed does causes some ripple effects – somewhere – and things have been affected by the Fed’s actions or inactions over the past six to seven years.  We are certainly doing better than we were, and we are doing a lot better than Europe who did not have a Fed type of organization calling shots and interfering with the economy.  However, there is not a clear acquiescence that the Fed’s actions contributed greatly to this and possibly the positive changes would have occurred anyway or would have occurred in spite of the Fed.  The U.S. economy is stronger and has more self-activating mechanisms including the initiative of its people than the EU and in spite of the conflicts within Congress, has a strong stable government able to act or not in the overall best interests of the people and economy

Long-term interest rates have been at record lows since 2008 because of economic malaise.  We’ve made a lot of progress job-wise during this period, but markets, businesses and investors look ahead and what they see is not what the Fed sees.  Hopefully things will change and we could look forward to substantial growth, but not right now.  Because of this, the Fed is wrong. Actually, the Fed is in the wrong business.  Let it stick to controlling short term rates to tweak employment and reacting to inflationary pressures, which is really their role.

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