Janet Yellen’s will-they, won’t-they waffling on the fence of raising interest rates is reminiscent if the will-they or won’t-they prelude to the termination of quantitative easing. Zerohedge said there would be a .125% interest rate increase, and they were wrong. Legions of market commentators predicted a raise in rates, and they were wrong. What is far more disconcerting, however, is the much tighter space the Fed finds itself in in terms of wiggle room.
Almost immediately following the Fed’s proclamation of inaction, proclamations of a December rate increase started pouring forth from mainstream media sources and even the Fed itself.
I’m pretty certain that I’m not alone in assessing the odds of higher interest rate guidance by the Fed at no better than 50:50. Let’s face it: their policy will be dictated by global economic circumstances the morning of the next FOMC meeting.
They have increasingly limited optionality. If they raise rates, they immediately put pressure on all of the emerging economies with U.S. dollar denominated loans, which, putting pressure on growth in that quarter, could catalyze an intensification of the global malaise. Stock markets – the target of central banks everywhere – could collapse.
If they don’t raise rates, though, the pension funds and insurance companies who have been enduring the brunt of this financial repression tactic of the Fed, have seen earnings evaporate and turn negative. The pass-through of losses manifests on the balance sheets of retirees, putting pressure on spending, the medical system and parents.
The third possibility bandied about predominantly by the non-mainstream media, suggests we will see a resumption of quantitative easing by the United States. The risk the Fed faces there is that, if they were to launch a new round of QE, if the effect on markets is muted or flat, traders will perceive that the ability of QE to move the market indices needle has ended, and so the result will only be exponentially more liquidity and credit, arguably the root cause of the current excessive inventories of everything from commodities to manufactured goods.
In any of these scenarios, the ameliorating effect of policy has a detrimental effect somewhere else in the real economy. Thus, the policy ‘tools’ persistently lauded by central bankers from Bernanke to Mario Draghi find themselves of diminishing effectiveness.
So where does that leave the world economy in this period of shrinking growth, exploding inventories and capacity, and diminishing wages and jobs? More importantly, what is left for central bankers to deploy in the battle against deflation and the pursuit of inflation?
The answer would appear to be nothing. As the largest capital pools in the world swap nominal values of derivatives of real assets -seldom the substance of such fantasy trading – instead of investing in the real economy, there is little chance for a real economic revival.
Welcome to twenty years plus of Japanese-style economic stagnation.
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