One Step Forward, Two Steps Back

  • Fed scales back yet again
  • Credibility becoming an issue
  • Risk for another major bubble

FINANCIAL MARKET DEPENDENCY  - Clearly the Fed doesn't want to do anything to rock the boat. It's time to forget about 'data dependency' and focus on what is really driving Fed policy. Financial market dependency. If the Fed were truly data dependent, it wouldn't have scaled back policy the way it did on Wednesday. And yet, with no real major changes since December, the Fed has now cut it's dot plot in half, projecting only 2 rate hikes in 2016. Has the Fed's credibility been undermined? I think it would be hard to not come to such a conclusion at this point. Guidance has been pretty awful over the past several years and it seems the only thing that may actually get the Fed moving to higher rates is a more noticeable pick up in inflation. Otherwise, the game of looking for whatever excuse it might be able to find to leave policy on hold will continue. 

EROSION OF CREDIBILITY - So whats the big deal if the Fed leaves policy as is? Well, the big deal is that either 1) It fuels a further bubbling of asset prices, which ultimately blow up, resulting in another major crisis, or 2) the market loses confidence in these accommodative policy gestures and starts to sell off, which leaves the Fed with no additional ammunition, exposing the market to a more intensified acceleration of declines as inflation picks up and the economy continues to struggle. So in my view, this isn't the way the Fed should be moving. I think the Fed should stick to its guns and keep on with raising rates. Small rate rises won't do much to stifle the real economy, and could actually help, perhaps freeing up some more lending and allowing savers to save. This strategy of one step forward, two steps back only serves to erode at the credibility of the Fed and ultimately artificially support a market that needs to stand on its own two feet. I would be very careful about buying into this latest risk rally and am betting that risk correlated currencies once again come under pressure. My bet is on the Canadian Dollar weakening at the moment. Let's see how it plays out. 

This Fed strategy of one step forward, two steps back only serves to erode credibility. Via @joelkruger

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