Central banks shooting blanks


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Throughout last year, I predicted the Federal Reserve wouldn’t raise rates by September and that it was unlikely to do anything to seriously rock the rate boat at all.

That turned out to be accurate.

On December 16, the Fed did raise rates — sort of. I say that because the Fed utilized the smallest increment possible, 25 basis points, in shifting the target Fed Funds’ rate interval to .25 percent–.50 percent from 0–.25 percent. 

The action was couched with carefully constructed language to indicate the measure was akin to dipping a toe in icy water. It will not be followed by a full-body dive-in, but by, at most, another dipped toe and a dash back to the warmth of inertia. There are five main reasons why relative inertia will remain the Fed’s preferred modus operandi.

RATE HIKE NOT HELPING

First, and most obviously, the world remains in economic and financial shambles. Emerging markets in the global south and East Asian regions continue to falter. If the Fed were truly embarking upon a systematic policy of raising rates, it would entail maintaining the pretense of a strong US economy, impervious to global meltdowns, as if the US operates in a vacuum. A false Fed bravado combined with downward-spiraling international realities do not equate to massive US monetary-policy change.

Second, US stock markets didn’t respond well. The Fed watches them closely, despite public claims of being laser-focused on unemployment and inflation figures. Corporations rely on cheap money to invest in share buybacks; the banks enable them to access said cheap money. Meaningful rate rises are bad for bonuses linked to share prices. Plus, Wall Street would rather access cheap liquidity for speculative purposes than pay tangible amounts of interest on savings accounts. 

Since the Fed raised rates, the Dow shed about 10 percent from its record close last May and fell 6.19 percent in its worst five-day start to a year ever. Markets worldwide nosedived. The broad Stoxx Europe 600 index ended down 6.7 percent during the first week of 2016.

Third, the dollar gained ground against most major and emerging-market currencies during the first week of 2016, reaching its highest level in more than 13 years, because other countries are doing that much worse than the US. The yuan dropped to its weakest level against the dollar since December 2010. The Fed doesn’t want a strong dollar — which proves how ineffective its policies have been in avoiding that.

Fourth, given the oversupply and speculation in the crude-oil market right now, from a physical and financial-trading perspective, oil prices are likely to remain low for the near future. Thus, the idea of raising rates to cool off inflation is a non-starter. Oil-related companies, which already made up about 60 percent of corporate defaults in 2015, will continue to struggle with declining revenues and default due to sustained low oil prices in 2016. It’s not just the oil industry either. According to Standard & Poor’s, “a staggering 72 percent of bonds in the metals, mining and steel industry are currently distressed.” 

Rate hikes would only exacerbate these debt problems, which would further hurt banks on the hook for loans, and investors on the hook for their bond and stock purchases. As I’ve discussed in the Trends Journal before, under our current environment of bankism, the Fed’s primary mission is to protect big banks. Ergo, no major rate hikes. 

Fifth, all of the above will lead to more job cuts, which will lead to worse unemployment figures, which will lead to the Fed not going hog-wild on rate hikes. 

FEAR AND CLUELESSNESS

The Fed remains mired in a policy of fear, cluelessness and lack of decisiveness that has characterized its cheap “money-printing” policy going into its eighth year. The business media praised the rate raise as if it were the coming of a new monetary-policy era. It wasn’t. The proof is in the extent to which the Fed exuded laissez-faire verbiage to hedge its own rate-rise announcement as an indicator of things to come. 

Indeed, the Fed underscored that its “stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.” Let that sink in. Even after raising rates a smidge, the Fed still promised accommodative monetary policy.

What was the point then? Just this: Fed Chairwoman Janet Yellen can rest assured she did something that former Fed Chairman Ben Bernanke did not. Her legacy is thereby rendered different — by a fraction. But let’s examine more backtracking language contained in the Fed’s latest announcement to determine what the trend is for this year: http://1.usa.gov/1P8yfzY

Consider its statement: “Net exports have been soft” followed by “the drag on US economic activity from the appreciation of the dollar since the summer of 2014 and the slowdown in foreign economic growth, particularly in emerging-market economies, was likely to continue to depress US net exports.” 

The Federal Open Market Committee acknowledges concerns that any “further dollar appreciation” could hurt emerging markets more, and that in turn would hurt the US. With the dollar at high levels relative to other currencies, those countries are buying fewer US products and services. This is negative for maintaining all of the US jobs supporting those products and services. This means layoffs and higher actual unemployment levels in the US and abroad.

Next, the Fed admitted inflation will likely remain low: “Market-based measures-of-inflation compensation remain low.” This is mostly because oil prices will remain hampered by oversupply, lower demand and speculation. Since Saudi Arabia and Iran are embroiled in ongoing power battles, neither OPEC country is about to relinquish oil-supply activities. Plus, various international economies are contracting or hovering at status quo, which means their oil demand will remain muted. Add in a plethora of shorts in oil futures and options, and related inflation just isn’t in the cards this year. 

FED’S REALITY ITS OWN

Then there’s this gem: “…Taking into account domestic and international developments, the committee sees the risks to the outlook for both economic activity and the labor market as balanced.”

All this means is that the Fed doesn’t function in the real world, but in some alternative universe of models and projections.  

The Fed admitted as much in this last item: “Economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds ra
te… However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”

This negates the prior sentence, but re-confirms the Fed’s lack of commitment to hiking, and buys the Fed time to hope the US and global economies magically improve — while supporting big banks’ liquidity needs as they incur losses due to mounting defaults on the loans they provided with the cheap money the Fed bestowed upon them. http://reut.rs/1OPvzWc

RATES, LIQUIDITY AND CAPITAL FLOW WARS

To sum up, a decisive policy of rate hikes is not in the 2016 cards, unless economies markedly improve — which won’t happen. At most, we can expect to get another 25–50 basis points this year. If markets continue to implode through the world as January exhibited, it’s unlikely the Fed will raise rates during the first quarter. If markets and banks’ books improve slightly, the Fed will raise rates by at most 25 basis points in the first quarter. But that’s a big “if.” The same goes for the second and third quarters. By the fourth quarter, if markets are still staggering, the Fed won’t raise rates into the US elections because diving markets don’t look good for the political party in power — or the Fed itself.

Meanwhile, most other central banks (with the exception of Brazil) remain in quantitative-easing mode or mirror mode to the Fed. It’s likely even more creative QE measures among elite central banks will sprout if liquidity, markets or commodity values decline. Less powerful central banks will be forced to respond to the needs of their local economies while balancing the strains imposed upon them by the actions of elite central banks. 

This means central banks will remain engaged in liquidity and capital-flow wars, trying to ensure that capital flows within their domestic-banking system and from beyond their borders. This will be particularly apparent in China, Europe and Japan. 

The People’s Bank of China likely will inject more liquidity into their banks through extra reserve-requirement reductions. This will prove doubly costly; China already last year used more than a half-trillion dollars, including the biggest monthly amount on record of $107.9 billion in December, defending the yuan — despite having to devalue its currency multiple times since August 2015 due to speculative market forces. 

The European Central Bank already has extended its QE or bond-buying program to maintain zero-to-negative rates to 2017 from late 2016. The Bank of Japan is accelerating its QE program as well, and already held a record 315 trillion yen ($2.6 trillion) of Japanese government bonds as of the third quarter of 2015. That’s 30.3 percent of that market.     TJ

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