In September, despite the market’s speculating that the Fed might raise interest rates, the Fed decided to leave rates unchanged, postponing a rate hike.
Despite our guess, it also did not particularly emphasize its intention to raise rates within the year, even though there is an obvious difference of recognition between the Fed and investors in expecting how fast the Fed is going to raise rates in the next few years.
Is the Fed intentionally leaving the gap as it is? If the answer is yes, and there is some hidden strategy behind the Fed’s attitude, it might imply what the Fed truly wants to do, and it is neither about the labour market nor the inflation. It is something else.
The gap of recognition between the Fed and investors
Federal funds futures clearly suggest investors expect future rate hikes in a much more moderate pace than the Fed itself insists, and the Fed policymakers should know of the gap. Then, why did they not try to narrow the gap? Some of the investors are still dreaming that the Fed might eternally keep rates low, as some of them even expected the Fed could restart the QE during the market turmoil in August.
Is the Fed really going to keep low interest rates forever? The answer is no, because it is not compatible with the fact that the Fed mentioned in the statement that its positive view on the economy did not change in a long-term basis.
Then, why does the Fed not narrow the gap? The most simple speculation is that it undervalues the danger of the gap and will surprise the market in an undesirable manner when it actually raises rates. Yet, is the Fed so simple-minded and inconsiderate? The former Fed Chair Ben Bernanke said, “monetary policy is 98 percent talk and only two percent action”.
If the Fed is not dull
Then, we came up with the second possibility: the Fed is degassing the stock market bubble, adjusting the volatility. We may remember Fed Chair Janet Yellen once mentioned in May, “the equity market valuations generally are quite high”, and, “there are potential dangers there”.
After the FOMC meeting in Sep, Atlanta Fed President Dennis Lockhart also said, “volatility can be a symptom of more fundamental ills”.
What are the “more fundamental ills”? If you have read our articles, you might think of what is the ills. It is the QE bubble caused by portfolio rebalancing.
We believe and conclude the Fed is neither focusing on the labour market nor inflation, but it is worried the most about the collapse of the QE bubble. To learn how the bubble has been created, read the article above.
Therefore, the Fed had no reason to raise rates in September, as the stock market was already moderately going down. As long as the bubble does not radically collapse, the Fed has no reason to raise interest rates. On the other hand, if the US stock market goes up, the Fed will raise interest rates to eliminate the cause of the bubble. We consider this destines the future move of S&P 500.
The second factor that affects the Fed
By the way, the Fed’s action is not only affected by the financial markets but also by other central banks. The Fed must raise interest rates at least faster than the Bank of Japan and European Central Bank. For details please read the article below:
The relationships between the central banks are crucial as the cause of Black Monday in 1987 was that the central banks failed to cooperate. The problem is that the situation in 2015 is becoming similar to 1987 as we explained in the following article:
Will the Fed be able to handle the QE bubble? Some great investors have already noticed the bubble and are carefully watching how it eventually goes. Investors must be vigilant, but there will be a great chance as we wait.