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What’s Worrying The Fed?

Before I launch into this week’s topic, let me mention that at the bottom of this blog, you will find a link to a speech I made recently: How Capitalism Died & Where That Leaves Us. The production quality of this video is particularly good, so I hope you’ll watch it. But, before you do, let me tell you what the Fed’s worrying about these days.

Now that the Fed has announced that QE will end in October, the financial markets are very keen to know when it intends to begin increasing interest rates. This is a very sensitive subject, fraught with danger. When the Fed began increasing interest rates in 1994, it caused near panic in the bond market and a significant stock market selloff. So Janet Yellen and her colleagues on the Federal Open Market Committee, which sets interest rates, understand that they must weigh their words very carefully when discussing their intentions on this issue.

All they are saying at this stage is that “the current target range for the federal funds rate likely will be appropriate for a considerable period after the asset purchase program ends….” and “economic conditions may, for some time, warrant keeping the federal funds rate below levels that the Committee views as normal in the longer run.”

Decoded, that means they don’t plan to increase interest rates any time soon and that, even after they do begin, it is likely that rates will remain unusually low for a very long time.

The Fed is reluctant to even talk about raising interest rates because it understands that the economy remains very weak. While it is true that the unemployment rate has come down more quickly than anticipated (it is currently 6.1%), that headline number masks a great deal of weakness that still persists in the labor market. Nine and a half million people are unemployed and roughly that many more are underemployed or, in other words, working part-time jobs because that’s all they can get. Making matters worse, wages are stagnant. According to a recent Fed report, “Over the past five years, the various measures of nominal hourly compensation have increased roughly 2 percent per year, on average.” And that is before inflation. After inflation, wages have barely budged since 2009.

What’s really troubling the Fed, however, is a racking fear that the economy will start moving back into recession as soon as QE3 ends – just as it did after QE1 and QE2 came to an end. And, they are certainly right to be worried. The Fed has been driving economic growth by printing money and pushing up asset prices. That has worked, but asset prices are now overvalued and there’s a very real chance that they will slump again as soon as the Fed stops pumping new liquidity into the financial markets.

Therefore, like me, the Fed must consider any expectations concerning a near-term rise in interest rates as premature, if not entirely unrealistic. The economy has been very weak even with 0% interest rates and massive liquidity injections through Quantitative Easing. It is disturbing to imagine what would happen if interest rates actually started to rise.

OK, now, for a good overview of how we got into this mess and how things really stand, click on the following link to watch my speech:

http://www.richardduncaneconomics.com/watch-richard-duncans-speech-how-capitalism-died-where-that-leaves-us/