So Janet Yellen and the rest of the Federal Reserve Board of Governors voting members decided to hold off longer on tightening. Since the announcement came out the S&P 500 has dropped roughly 50 points as of mid-morning today. “Perhaps a little buy the rumor, sell the fact” action. How much would the market be down if they had raised interest rates 25-basis points to a Fed Funds target of 0.25% to 0.50%? Remember this is what we are discussing.
We argued here that it was time for the Fed to get on with a tightening regime. We are six years into a recovery and the Fed Funds target has remained basically at zero. Yellen talked about the recent market volatility and concerns over China, but if she is waiting for the perfect time with no global economic worries, she will be waiting forever.
Matt Weller makes the point that the Fed could have gone in four directions, not just two. And it seems to have moved in the direction that leaves the greatest uncertainty. We have argued that it is this uncertainty that has driven market volatility more than anything else, despite the protestations from the Fed.
Of course, it is possible the there is more to this. Andrew Wilkinson makes a somewhat chilling observation in a recent post. In analyzing the Fed’s “Dot plot” he says there may be some officials looking to ease rates further. That would mean that six years into a recovery with the unemployment rate going from above 10% to 5.4%, some Fed officials think we should move from contemplating a rate increase to going back to easing/QE mode. Talk about uncertainty.
It seems ever counterintuitive, but the point must again be made that the Fed Funds rate is pegged at 0-0.25%. We are not talking about moving it from a relative level of equilibrium to something that would slow down an overheated economy. That level would be somewhere in the neighborhood of 400-basis-point from where we are at right now.
We know that the Fed has been getting a lot of pushback from the International community—the International Monetary Fund in particular—over a potential rate hike. I am unsure of the precedent but I do know that the Eurozone and China in particular, does not react well when U.S. officials try and dictate their policy. Numerous U.S. Treasury Secretaries have implored China to stop manipulating its currency, to no avail.
The Fed has a specific mandate and while it cannot ignore the rest of the world, it needs to follow its own mandate and make judgements based on what is right for the U.S. economy. Most analysts saw that point being yesterday. So much so that equities sold off, similar to its “Taper Tantrum” two years ago, in anticpation of a rate hike. First, why go through that all over again, and more importantly, should the Fed allow itself to be bullied by the market, and the IMF?
The real reason?
Besides the sharp downturn in the Chinese stock market, the correction in the U.S. equities may have played a role in the Fed’s decision. While, arguably, the belief the Fed would tighten at its September meeting was a driving factor in market weakness, there is growing group of analysts that expect a much more severe downturn—and have targeted this September/October period. No doubt the Fed officials have seen this analysis and fear being blamed for a market crash.
It is not out of question that some Fed officials would like to get through the historically volatile month of October before taking action; lest it gets blamed for a long overdue market correction turning into a crash.
All this over a measly 25 basis points.