3 Things: Fed Levitation, Employment, Savings Rate

Fed Levitation

What is going on at the Federal Reserve? On Tuesday, Janet Yellen comes out and announces that despite inflation being on the rise and employment below 5%, she is not going to raise the Fed Funds rate 4-times this year, nor even two times this year, but rather most likely none. Of course, this “one and done” scenario is what I suggested back in December following the first rate hike given the ongoing deterioration in the underlying economic backdrop.

However, on Wednesday, Chicago Federal Reserve President Charles Evans comes out and suggests he would support another interest rate increase in June.

So what is it? Are we “data dependent” or are we more concerned about “global economic weakness?” Or, is this just part of the Fed’s careful orchestration to support asset markets?

I think it may just be the latter as the Fed comes to the realization they have gotten themselves caught in a “liquidity trap.” Here is their dilemma?

Low interest rates have failed to spark organic economic growth which would lead to an inflationary pressure build.

While QE programs fueled higher asset prices, the “wealth effect” did not transfer through the real economy as the programs acted as a “wealth transfer” from the middle-class.

The Fed cannot afford to have a major reversion in asset prices which would crush consumer confidence pushing the economy into a recession.

The unintended consequence of announcing rate hikes was a surge in the U.S. dollar, as discussed earlier this week, as foreign funds chased higher yields. This surge in the dollar crushed corporate profits and oil prices putting a further strain on economic growth.

Further monetary policy accommodations would risk a surge in asset prices that expands the current over-valuation of markets and magnify the eventual reversion.

The Federal Reserve has carefully orchestrated a very balanced messaging process to support asset markets but taper enthusiasm by sending contradictory messages. Yellen suggests ongoing “accommodation” which pushed liquidity into “risk” assets. That excitement is immediately tapered by a contradictory message that “less accommodation” is still likely.

The Federal Reserve is trying very clearly to accomplish several goals through their very confusing “forward guidance:”