Pop Goes The Confidence In The Fed

by: Scout Finance

Summary

The Fed is making confusing statements.

The implied probability of a rate hike in April is negligible.

I don't think the Fed will raise rates this year because of a weak economy.

The market has done nothing in 17 months, but what is going on behind the scenes is quite remarkable. The business cycle is turning over. It is occurring at a glacial speed in fits and starts, but it is rolling over. The concept that some economists and Fed officials believe the economy will grow at 2% forever is bizarre. They must have missed the last cycle and the one before that.

The reason why I say what is going on behind the scenes is remarkable is because the Fed truly has become unhinged with its policy statements. Open mouth policies are probably even more critical than actual policy decisions because the market prices in possibilities of actions occurring. When the Fed makes a statement, the market takes it seriously by parsing through every detail. You can see the analysis on CNBC and you can see the market's volatility in action after various policy speeches.

The headlines out of the Fed have been coming very fast. In my perspective, I cannot even keep up with each Fed president's comments because they are dysfunctional to say the least. As I have said, open mouth policy ramifications are massive. The Fed boxes itself into a corner with forward guidance, so it really can't make a policy move which shocks the market, especially with the way this Fed monitors the market.

An example of this in action is Bullard's recent comments where he said "You could probably make a case for moving in April" on March 24th. If I was a Fed governor who was hawkish, I would keep my mouth shut if I knew the group was going to make a policy decision which was dovish. It creates chaos to have governors making contradictory statements. Sometimes they even contradict themselves. The only reason why I would make statements contrary to Yellen if I was Bullard is if I was strongly against the dovish policy or I was nervous about the possible ramifications of ZIRP policy. I think this is the latter case for Bullard.

To quantify my point, as of April 8th the implied probability of the Fed raising rates on April 27th is 2%. The Fed cannot raise rates unless it wants to see the market down at least 2% on the day. Considering the backlash the market gave the Fed after its rate hike in December, I do not see that happening.

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The most important of the probabilities shown on the CME website is the December meeting because it represents the entire year's decisions. The Fed seems to guide based on the calendar year. For example, it moved from 4 to 2 rate hikes in 2016. This sets up the Fed having a weird battle with the calendar as it doesn't raise rates as the year moves on, but it continues to say it will. This caused the Fed to raise rates last December in a moment where it had to do so to maintain credibility.

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In a perfect world the Fed should not be worried about credibility. It should only be worried about good policy. The problem is that the good policy decision would be to not raise rates this year. However if it doesn't it will go against what it has guided, leave itself with no wiggle room to cut if we head into recession, and it will lose credibility which would make a possible QE4 ineffective.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.