The Federal Reserve plays chicken with markets…and swerves

Most people think the Federal Reserve proactively sets economic policy. I believe the opposite is the case: that the Fed follows markets.

Proof for my view occurred yesterday. After years of preparing markets for a rise in interest rates and making it clear that September was the expected liftoff, the Fed decided not to raise interest rates on Thursday. Why? Because, I think, the Fed was reacting to market prices.

Of course, the Fed had their excuses all lined up: China’s volatile markets, Europe’s problematic economy, crashing commodity prices, etc. Yes, those were reasonable concerns, but I don’t think that was the Fed’s real reason.

You see, markets had already decided the Fed wasn’t going to raise rates. Market participants had looked at the data and come to the conclusion that the economy was too soft to raise rates. You can see this clearly in the remarks of savvy investors like Jeffrey Gundlach and banking executives like Goldman Sachs’ Lloyd Blankfein.

Markets had priced in no raise, and the Fed then caved to that reality. It was a game of chicken between markets and the Fed, and the Fed swerved into the ditch. If the Fed had pressed on with raising rates, markets would have reacted violently–having priced in no raise. Then, the Fed would have been on the hook for explaining why they caused markets to tumble.

You can see the Catch 22 the Fed finds itself in. On the one hand, they are supposed to “take away the punch bowl” when the economic party gets too crazy. On the other hand, if market participants don’t factor that removed punch bowl into market prices, then market crashes can be blamed on the Fed.

Under my way of thinking, the Federal Reserve will raise interest rates when markets expect it and have factored that into prices. If the Fed acts before then, they can and will be blamed for market volatility, a position no set of bureaucrats wants to find themselves in.

So, sit back and watch the Fed’s goings on with amusement. This circus is for the crowd, but it’s not important.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

The Federal Reserve plays chicken with markets…and swerves