Fed Leaves Rates Unchanged And Becomes More Dovish

by: Nima Karamlou

Summary

The Fed has decided to leave rates on hold, as expected.

What was not expected was the dial back of hawkishness, potentially presenting a cause for caution.

No rate hike expected until September/December.

The Fed has decidedly left rates unchanged. To my expectations, I had assumed the Fed would remain somewhat hawkish regarding the status of the economy. This, however, did not turn out to be the case as the Fed became even more dovish, dialing back their rate hike assumptions for 2016 and 2017. I don't think any one expected a rate hike with the pending Brexit vote and the weak jobs number. However, the Fed's credibility has become questionable at best and here we will examine some of this disconnect.

The Problem:

The problem is that the Fed failed to raise rates when it should have. The fed speak has been bullish on the US economy. Ironically, they don't see the economy strong enough to withstand a mere 25 bps rate hike? The Fed had the opportunity to boost rates when the economy was adding 200k+ jobs. Currently, the jobs picture, which was the bright spot for the Fed, looks like it could be waning. With inflation failing to meet the 2% target a rate hike seems slim at best. With that being said, every one knows that the Fed has to have some gas in the tank to get it through a recession given the current situations. I think it will be increasingly challenging for the Fed to justify a rate hike with weak industrial production, a bubble auto market, and a slowing labor market. The Fed may rely on housing and inflation; however, the latter seems unlikely to meet the Fed's 2% target with wages failing to muster strong support.

What this means for the market:

The markets continue to be disconnected. The Fed's hope to coddle financial markets will ultimately end in disaster as their credibility has continued to lessen and the stock market fails to grind higher. While increasing money supply should provide support to asset prices, eventually, the nature of the fundamental picture will take hold and their will be a repricing of assets to reflect the lack of any economic growth. I think the fact that the Fed remained on hold for a 25 bps increase shows how fragile the economy is at these levels.

Conclusion:

The Fed's dovishness ahead of the Brexit seems contradictory given the earlier hawkish comments from a number of key Fed speakers. This is troubling, in my view, as it appears the drivers of monetary policy don't seem to be able to understand the economy or point the finger on where they think things might be. It again is another confirmation that the Fed's job is to coddle the markets and not to act as a steward for the economy. I expect that the Fed will remain mixed in commentary and likely wait until raising rates until after the summer. The Brexit vote could potentially dial back any rate increases for the duration of 2016.

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