Whether it is eroding its credibility as an institution, or leaving the inflatable water wings (AKA “floaties”) on the markets’ metaphorical arms to keep them afloat, the Federal Reserve’s decision not to raise interest rates at its September policy meeting is sending shockwaves across the globe.
Equities in both the U.S. and Europe sank fairly deep into the red on Friday afternoon, as only Asian stock markets appeared to escape the brunt of the aftershock from the Fed’s dovish decision. Nonetheless, Shanghai (+0.38%), Hong Kong (+0.30%), and Taiwan (+0.20%) only managed to add a measly third of a percentage point each, on average. The Dow Jones also lost 290 points on Friday.
Fed Stands Pat
Although most experts were split on whether or not they believed (for better or worse) that the Federal Reserve Open Market Committee (FOMC) would hike its benchmark interest rate for the first time in nearly a decade, it turned out that the decision not to raise rates was likely the more momentous of the two options. If the Fed had chosen instead to increase the federal funds rate by a mere quarter or eighth of a percent (25 or 12.5 basis points, respectively), it not only would have proved (for whatever it’s worth) that the central bank was serious in its claims to be moving toward normalizing monetary policy. The significance of this signal lies in its affirmation that the economy is indeed recovering—at least in the U.S.
The truth is that the move is largely symbolic, especially since it would be such a shallow increase to the benchmark rate. Even if the Fed moves its rate dramatically, it is merely a leading indicator (somewhat like the gold and silver fixes); it’s up to free market forces to bring actual interest rates into agreement with the fed funds rate in practice. By not raising rates, it would seem that the Fed is levying an indictment against the health of the economy and the global markets.
Furthermore, by not raising rates, the Fed is not only expressing its concern over whether the global markets are ready for such a policy shift; it’s also conceding that sees an actual benefit in leaving in place its unconventional regime of essentially zero-interest access to money—an easy-credit, free-money environment.
Grasping for Reasons
Chair Yellen invoked “China” 16 separate times during her post-meeting press conference, harping on the risk from the volatile swings in the equities and currency markets for the world’s second-largest economy. Although there’s no doubt that China has an increasingly important role to play in how major central banks generally coordinate (read: collude) on monetary policy, this line of reasoning from Ms. Yellen seems awfully pessimistic. So, too, did the overwhelming 9-to-1 vote by the FOMC not to raise rates. (Only policy hawk Jeffrey Lacker dissented from the consensus.) Clearly, the committee was far less divided than the public believed—and less divided than the public itself.
With no post-meeting statement expected from Yellen after the FOMC’s October meeting, expectations now shift toward December being the most likely timing for a rate hike liftoff. With this in mind, investors have piled back into government bonds, bringing yields on benchmark 10-year Treasurys 13 basis points lower over the course of the week, from a high of 2.26% (when a rate hike seemed a strong possibility) down to 2.13% on Friday afternoon.
There is still virtually no inflation even after the unrestrained use of the supposed deflation-fighting emergency measure popularly known as quantitative easing (i.e. monetary stimulus). This is true not only in America, but in Europe and Japan, as well. Amid such a prolonged period of abnormal inflation, it seems the Fed is drinking the Kool-Aid of NIRP/ZIRP being the “new normal” rather than an aberration.