You Need To Know The Fed ISN’T Important. Here’s Why 2
In order to see if the Fed continues to take longer before raising rates, we will have to see how long they wait before raising rates in the current cycle.
This of course raises the very valid question, is it not reasonable for the Fed to take longer to make their decisions given very uncertain economic conditions?
In the minds of the Fed, or more specifically, the FOMC, this means that for rate hikes, they want to be sure (or as sure as anyone can be) that the economy is “ready” for higher interest rates. Simply because they are afraid higher rates will choke off economic growth by causing people to borrow less.
This hesitancy to raise rates must be balanced against the dangers of letting inflation take root, which is supposedly stoked by low rates which encourage people to borrow and spend.
Rate cuts, on the other hand, come at the same problem from the opposite direction.
If the economy is growing at a nice clip and prices are generally rising in a good way, central banks require strong and consistent evidence that conditions are deteriorating before cutting rates. Here, their main concern is to not supercharge existing inflation with their rate cuts.
The way the Fed and other central banks go about deciding if the time is right to raise or cut interest rates is by looking at economic data and conditions in the financial markets, specifically in the fixed income (bonds) segment.
At first blush, this seems reasonable and normal.
But, if one thinks about it a little more, doesn’t the market look at the same data in order to make its own projections, while also trying to predict what the Fed will do, and adjust asset prices accordingly?
As such, the Fed, by basing their decisions on the same data while also weighting market conditions, just creates a circular reference.
The crucial issue at hand is this: the Fed believes that market determined financial conditions are a good enough signaling mechanism to consider them when enacting monetary policy.
So what makes the Fed more capable of projecting future economic and financial conditions?
After all, if someone is projecting the future by basing their opinions on a source that already projects the future, what use is there for that someone?
On top of this, the reason the Fed takes into account market prices and conditions is because the market, especially in USTs, has proven prescient on multiple occasions. If the bond market reliably distills the “Wisdom Of The Crowd”, what use is there for the Fed’s current form of monetary policy?
Let’s not forget that the economy takes the interest rates set by the markets. The Fed, in its current policy framework, seeks to influence the rates set by the market, and from there the broader economy.
Hence, the Fed touches the economy only in an indirect way. Given that the Fed’s interest rate decisions consistently lag turning points in US 2 year yields, the Fed’s policy of targeting interest rates really is of little practical consequence.
Consequently, the Fed trying to influence interest rates indirectly, by using market prices and conditions as inputs into their decision making, is no different from traders and investors looking at markets to figure out what the future holds.
Which means that, at the end of the day, the Fed is just like these traders and investors – subject to the timing of their investment decisions, whether they actively try to time the market or not.
If so, why the pretense of analysis and delays in changing their policy stance? They are just going to lag the bond market anyway.
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