FOMC Policies: Why the US Federal Reserve Waffles

Sometimes media presents a different context than the indicated headline.

A noteworthy example has been today’s breaking news from Philippine business news provider, the Businessworld

The expert quote in the terse article “bar is low for the Fed to raise rates” patently diverges from “Fed moves closer to raising interest rates.

This isn’t pettifogging. To consider that much of the public’s actions can be traced to what has been fed by mainstream (for instance the weak peso); the contrasting message may confound readers. Or readers may just ignore the quote and stick with the headlines.

Nonetheless this Wall Street Journal Blog also sees a dovish tendency by the FOMC’s statement: Many bond investors are skeptical that the Federal Reserve will clearly signal a September rate increase at the conclusion of the central bank’s policy meeting on Wednesday. 

And so has this Reuters report which attributes the yesterday's buoyancy on US stocks to low interest rate expectations on Fed actions.

However, here is the actual FOMC statement: (bold mine)

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

As usual, the Fed's assessment has been data-dependent, meaning based on ex-post (past performance) analysis, but whose policy decisions will be predicated on ex-ante (anticipated changes). In short, for the FOMC, the immediate past will be projected into the future as basis of decisions. They have barely provide room for alternative response-reaction paths.

So given the above litany of factors for consideration, the FOMC seem as moving goalposts. They have been looking for various excuses or alibis to justify the postponement of raising rates.

Why so? Sovereign Man's Simon Black describes the Fed's addiction to zero bound:

In the US, market manipulation has taken on a much more sophisticated approach.

It caught my attention last week that the Federal Reserve’s balance sheet is still within 0.3% of its all-time high.

All the fanfare about Quantitative Easing coming to an end, and the Fed cleaning up its balance sheet, turned out to be a load of bull.

When the Fed entered the financial crisis in 2008, its balance sheet was roughly $900 billion.

At its peak, its balance sheet totaled $4.5 trillion. Today, it’s still at $4.5 trillion.

So much for a new era of responsibility.

But to give you a sense of how closely tied the Federal Reserve is to financial markets in the US, this morning I pulled the data and plotted the two together.

This chart shows the relationship between the size of the Federal Reserve’s balance sheet and the Dow Jones Industrial Average since the start of the crisis in late 2008:

You can see that the market stays within a tight range, and as Quantitative Easing played out over the years, that range became even tighter.

Even now that Quantitative Easing has supposedly ended, the ratio between the Fed’s balance sheet and the Dow Jones Industrial Average remains nearly constant at 253x, with a standard deviation of just 1.5%.

That’s a fancy way of saying that, whether intentional or not, the Fed is completely dominating the US stock market.

It’s the same story with mortgages. Treasury bonds. And just about every other major asset class in the US.

Which means that any shrinkage of the Fed’s balance sheet will drag down markets with it.

The Fed may not be as brash as China, but their unsustainable support for financial markets is just as precarious.

This is a time for extreme caution; there’s simply been too much pressure built up in the system, and there’s no way of knowing when or where it’s going to be released.

The Fed's dependence on bubble blowing have become so deeply rooted. With the prospects of painful adjustments, this makes withdrawal hardly an option. This applies not only to the Fed, but almost to the entire spectrum of central banking operations worldwide.