Don´t fight the Fed

The Fed has left many people puzzled over what it wants to achieve by raising rates this March and projecting two more rises this year, plus several more in the two following years.

Core PCE inflation is flat. The Fed should not look at headline inflation, PCE or CPI.  Wage growth has possibly picked up a bit, possibly not. Unemployment is low, to be sure, but so are participation rates.

So, why the tightening? Yellen constantly worries about being behind the curve and having to raise rates so quickly in the event of a rapid nominal acceleration of the economy that would then cause the economy to crash. There is no evidence for a rapid acceleration, just a Trump confidence bounce that needs action, not forthcoming, on the supply side to sustain it.

The very fact of her worrying so much about an acceleration means it will not happen. That is the power of expectations. In fact, the reverse may happen.

It still seems as if “normalization” is their main driver. The Fed wants rates higher as it sees rates as the main tool for monetary policy and unless they are higher, they cannot be cut if bad news were to appear. However, the “normalization” could cause the bad news even if the Fed seems very sensitive to markets. That happened in January 2016 when Fischer threatened, sorry “projected” four rate rises that year. It spooked stocks badly, and the Fed went quickly into reverse.

The current confusion in markets is likely to give way to a less nuanced, less subtle, view of the Fed’s intentions. The old “don’t fight the Fed” meme will reappear. The last time it came up frequently was in the rally of 2009-11, as the Fed got on top of its 2008 policy errors.

This time it will come up because the Fed, if not actually wanting markets to fall, does seem to want to cap them. If true, markets will probably fall and the Fed will have to reverse its monetary tightening course, just as it did after the January 2016 debacle.


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