More Confusion from the Fed

September 23rd, 2016 by

For all of its miscalculations, mistakes, and policy difficulties, the best thing that the Federal Reserve could give to the markets is clarity.

This, however, is not part of the central bank’s modus operandi. Nor is it likely to happen in the near future.

Capitalizing On Confusion

Alan Greenspan is credited with starting the practice known as “Fedspeak.” This strategy is sometimes painted as an innocent way of avoiding unnecessary market fluctuations based on what a prominent Fed official says. To avoid such sharp reactions that could undermine the central bank’s plans, Greenspan and his successors have made a sport of dissimulating and using vague—often indecipherable—language that ultimately tells us nothing about which direction monetary policy is headed.

While Fed Chair Janet Yellen and the other FOMC members may employ Fedspeak for these same reasons, there are negative side-effects beyond the Fed trying to keep markets calm.

Janet Yellen: half-dove, half-hawk? Image courtesy of MarketWatch

For instance, when the Fed expresses optimism about the improvement of the economy but fails to raise interest rates even a quarter point (25 basis points), observers must realize there’s some disconnect going on. Unemployment is below 5%, which was once seen as nearing “full employment.” (It’s also interesting that the steadying labor participation rate may not indicate that more people are entering the job market—merely that people are remaining unemployed for longer rather than dropping out of the labor pool entirely.) If the U.S. economy can’t handle even a modest rate hike for the first time in nine months, even after a record number of consecutive months of supposed job growth and modest expansion, how strong is it, really?

Zero Lower Bound

confusedAlthough the implementation of negative interest rates elsewhere in the world appear to have invalidated the idea of a “zero lower bound” for these benchmark rates, the concept still holds in the context of Federal Reserve policy. The central bank has thus far rejected the idea that subzero interest rates could work in the U.S., and instead used the 0% to 0.25% range of the federal funds rate as its lower bound.

We have seen just one rate increase from this lower bound, which took place last December. Former Minnesota Fed President Narayana Kocherlakota says this strategy of gradually normalizing rates might have worked under normal circumstances. He uses the metaphor of a rocket lifting off from Earth’s orbit to illustrate this. With eight years of extreme monetary policy, however, he says the situation is more akin to trying to lift off from Jupiter, not Earth. The gravitational pull of the zero lower bound is much harder to escape than previously imagined.

Boosting Gold

At any rate, the uncertainty swirling around the Fed’s decisions has been a boon for gold. Not only has the yellow metal picked up in the wake of the (non)decision by the FOMC this week, but it has also outperformed the commodities sector in general.

This is undoubtedly because gold prices are so sensitive to economic news and interest-rate decisions. In addition, ultra-low rates mean there’s less incentive to stash your money in the bank or sink it into a government bond, while at the same time this has reduced the holding cost of gold. As investors continue to pine for a viable store of wealth, gold continues to extend its longest rally since 2011.


The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.