Fed Chairwoman Janet Yellen has a plan: she wants to follow up on the December rate hike with three more quarter-point increases in 2017. The reasons, she claims, are an improving labour market and rising inflation, expected to reach 2% over the medium term. We are to believe that the Fed has successfully guided us out of the Great Recession and manufactured a recovery and a smooth transition from the accommodative monetary policy is all that is left before it’s officially time for a victory parade.
While large parts of the markets are gullibly buying the story, others, including us, see an economy characterized by bubbles in everything from Chinese real estate to US auto loans and European government debt, which will not be able to withstand any meaningful increase in interest rates. Are we to believe that the Fed is blissfully ignorant of overinflated markets across the globe? Or is the Fed not being honest about its motives?
While it is plausible that the Keynesian disciples on the FOMC buy into the concept of the centrally planned recovery, it is implausible that no-one on the committee sees the warning signs ahead. Rather, the hawkish rhetoric may hide concern about the Fed’s current impotence to deliver on a well-established, but unofficial policy: the Greenspan Put.
Since the stock market crash in 1987 was met with an immediate rate cut, equity markets have come to rely on the so-called Greenspan Put, a non-explicit guarantee that the Fed’s interest rate policy is underwriting the stock markets. Signs of crisis have since been met with monetary accommodation.
With rates at rock-bottom, the blunt instrument of rate cuts has been replaced with rhetoric. We saw it in the summer of 2015, where the so-called Taper Tantrum led the Fed to quickly abandon hawkish rhetoric. The sell-off this year in January was also met with a quick retreat from talk of the then foreseen three rate hikes in 2016. So far this has proved sufficient, but with bubbles growing ever bigger and time indicating we may be due for the next downturn (in the era of central banking hegemony they seem to come around every 7-10 years), the Fed will be growing increasingly worried about their impotence in the face of renewed recession.
Alas, the Fed may not be so confident about the economic recovery, but instead increasingly worried about their inability to meet the next crash with aggressive easing. Talking up the economy may be hoped to facilitate a few rate hikes without causing the markets to crash, thereby buying the Fed some vital room to cut when the inevitable downturn arrives.
Conjuring up growth from the printing presses is of course beyond the Fed – stocking up some ammunition to bail out the markets and keep Armageddon at bay for another spell may be all they can hope for. But even that strategy is too ambitious. The world economy is too levered and 2017 is more likely to bring QE4 than a 1.50% Fed Funds Rate. The Fed is almost out of bullets and there is not enough time to re-load the gun.