The Economy, Interest Rates and the Federal Reserve

Posted on Sep 18 2015 - 11:11am by Sharpe Trade

We have stated … almost all year, that a raise in the target federal funds rate here in September by the Federal Reserve would surprise us.  And, as we expected, the Fed announced that …

Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term … the Committee today reaffirmed its view that the current 0 to 1/4 percent  target range for the federal funds rate remains appropriate …” – FOMC Statement, September 17, 2015

It seems everywhere I turn, individuals, investors and even economists are complaining that the Fed is acting too slow in raising the rate.  The argument seems to be that by looking at the landscape of labor, a delay in raising the rate makes no sense and at this point can only cause problems.

That may be true.  

It may not be true.

But we thought we would take a moment and discuss our thoughts as to the focus of Federal Reserve policy and at the same time, why we correctly did not expect the Fed to raise the rate.  We like to reach out, and try to help new self-directed retail investors and traders.  So we will attempt to keep this simple and clear.

We would challenge the view that the Federal Reserve is being overly cautious.  Or even, that they are ‘moving the goal-post’.   The markets are a non-linear, complex entity.  If we wish to use the analogy of a ‘goal-post’, it would be more accurate to say that the goal-post is being moved on the Fed, not by the Fed.  Could this cause problems later?  

Possibly.

Once again, as stated it seems that many who are mystified by the Federal Reserve’s decision to leave the Target rate unchanged, seem to be focusing on the labor backdrop.  Very sensible and intelligent.  Employment and labor metrics have been improving across the board.

And from 2009 to 2014, all focus was correctly on labor.  That is five years in which every economist has built models around and focused on … every employment metric known to man. However as previously outlined here at ‘Sharpe Trade‘ we believe the real story has shifted in it’s focus.  Although employment will always remain a concern, the majority of the driver in the markets from the end of 2014 has been been the strength of the dollar.    That is not a labor issue.  That is an inflation (or lack thereof) issue.

We also believe it is safe to say that employment as an issue has lost political momentum.

While lower crude prices do have some impact on inflation, and that whole ‘negative / positive’ conversation can be debated, we do not believe Crude Oil price to by the main driver of what is occurring here.  For the last ten to eleven months, on each and every conference call we listen to, we find companies being impacted negatively by the strength of the U.S. Dollar.  Which has been a natural headwind to earnings.  Earnings impact GDP.  GDP naturally leads us to inflation, or a lack of inflation. The strength of the U.S. Dollar has also naturally impacted Emerging markets negatively.

We are still becoming familiar with Chairman Yellen.  And we thought that these are the issues that the  Fed would pay attention to. We could not be certain.  

It turns out that we were correct.

Does it aggravate us that normalization has become what the Federal Reserve seems to fear?  Of course.  Do we ponder a possible ‘race to zero’ situation, in which the new ‘problem of the month’ will keep the Federal Reserve stuck at these levels?  Yes.  We think about that.  But again, we do not try to fight the Fed.  We simply seek to understand it.

We will continue to evaluate conditions as we move forward in time.

But for now?  We have a slowing economy with an elevated dollar, heading into our next earnings season.

We are not overly optimistic.

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