The Federal Open Market Committee (FOMC) meets Tuesday, April 26 to discuss Federal Reserve policy, the most important of which is whether interest rates will rise.
At the end of 2015, the Fed announced that it would be engaging in a series of rate hikes. We have thus far seen only one, with disastrous results for the stock market. We further know that the Fed will not raise rates during a time of economic weakness or if the inflation targets have been reached.
Let's take a look at the aspects that are likely being considered by the FOMC for the upcoming decision on interest rates.
State of the Economy
From the state of the economy, we can deduce that the FOMC will not be raising rates in the coming meeting. The US economy is too fragile at the moment because of its addiction to leverage and debt. Most concerning are the current debt levels in contrast with those of 2007 - this alone can obstruct the Fed from raising rates:
In some areas, the economy looks much like that of 2007. In other areas, it looks much worse.
Labor force participation is also concerning, having fallen continually since the last recession:
The present economy does not lend itself to the "hike" side of the debate on interest rates.
The entire rationale for controlling interest rates at a centralized level lies in Keynesian thinking: If we can manipulate interest rates, we can also manipulate inflation. Since 2012, the Fed has set an official target of 2% inflation (the Fed had that target prior to 2012 but only officially announced it in 2012). To justify raising rates, the Fed will need to witness an increase in inflation, bringing us over the 2% mark. We do not see that:
With its announcement that future policies will be "data-driven," the Fed has put its foot in its mouth, essentially restricting itself from raising rates.
We Are in a Balance Sheet Recession
I mention the idea of a balance sheet recession in this article about preparing for the next market crash. To recap: A balance sheet recession occurs when companies realize their balance sheets look like a mess and attempt to fix them, with buybacks and debt payments. This reduces borrowing, and the Fed attempts to stimulate borrowing by not raising rates but dropping rates.
In certain cases, we've seen negative interest rates following balance sheet recessions. Japan's "lost decade" was a balance sheet recession, so was the Great Depression. We are currently at the beginning of a new, much bigger balance sheet recession.
Whether the Fed sees this is questionable, however. Japan certainly did not see its balance sheet recession until several years after. Prime Minister Koizumi engaged in monetary policies, finding them to be ineffective.
Only later did Japan recognize its balance sheet recession, vote Abe into office, and start engaging in fiscal policies, which softened the blow and led to an effective recovery - albeit an arguably temporary one. The point is that even the central bankers and governments cannot recognize a balance sheet recession: The signs are hidden in company balance sheets, which is not the reading material of FOMC members or government bureaucrats. If they were, perhaps the US would take advantage of the current election and vote in a person aware of the recession.
Instead, we have an election interfering with the timing of a market crash. Few will argue that the stock market has not been artificially bolstered by funds from central banks. Even fewer will argue that the US election timing has little bearing on the length of time the asset bubble is artificially inflated.
The Chairman of the Fed is a Democrat and engages in private meetings with the Democratic president, who himself wants to see his Secretary of Defense take the torch. With the Fed having the power to, at the very least, push the market in a certain direction, the logical conclusion is that the Fed does not want to engage in any actions that might crash the market prior to the upcoming election. After all, the stock market performance three months prior to a US presidential election has nearly a 90% accuracy in predicting whether the incumbent party stays in power.
If this sounds like conspiracy, consider Alan Greenspan's comments that the Fed is not an apolitical entity. Or at the very least use history as your guide: Central banks around the world typically avoid changing interest rate policies the year of an election. Appointed by Obama, Yellen is likely willing to use her power to keep the stock market afloat until Hillary Clinton is elected - this means keeping interest rates low.
We should give the Fed the benefit of the doubt: It knows what it's doing. At the moment, its goal is to extend the lifetime of the asset bubble. Unfortunately, this is a mirror image of the repeat we had in 2006, with fiscal and monetary policies ultimately extending, but not solving, the real estate bubble.
For our current bubble, we have two escape routes: default or deflate. The latter is more desirable than the former and will require lower rates - possibly negative rates. As much as I'd like to see the rates raised to a sensible level, the Fed is "data-driven" and has little reason to engage in any action other than holding, or possibly cutting, rates.
(Optional) Political Commentary
I am not political in any sense and do not vote. That said, any candidate who is elected must deal with the balance sheet recession in the next four years. Americans should understand each candidate's understanding of this issue before voting.
I doubt Clinton understands the current balance sheet problem, making her a poor choice. Unfortunately, in Yellen's attempts to elect her preferred candidate, she ironically hurts the overall economy of the United States. But it is quite possible that Yellen herself does not know of the recession…
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