After last week’s Fed meeting, we can all take heart that the Fed is still supporting the global markets. But if the message of the markets is any indication, this may be the wrong approach.
I suspect this was a contentious meeting and that the committee struggled with whether or not to pivot to a tighter policy. The current funds rate has been near zero for more than six years, and while the recovery is not as strong as we had hoped for, the Fed’s extremely generous policy is now overstaying its welcome, leaving the markets confused by a policy that seems to have the Fed boxed in to a corner.
Think back two years ago when the markets balked at the removal (really, the taper) of QE in 2013 and into 2014. At the end of the day, it was the right thing to do, and the markets responded positively.
Let’s take a closer look at what happened: The Fed announced in October 2013 that they would start removing the generous $85 billion per month QE by $10 billion a month. The initial reaction was a pop in volatility – the VIX shot up to 20 and then moved right back down into the low teens – and a drop in the stock market. However, with some clarity on the situation, uncertainty was removed and the market bounced back, finishing the year higher by 10%.
We we moved into 2014, the “taper tantrum” that was expected turned out to be a non-event. Instead, the stock market rose in 2014 while the Fed was tapering, and when it ended a year later (October 2014), the SPX 500 was up more than 12%.
This should have been the same model followed by the Fed last week, so why didn’t the Fed follow through this time around?
That’s a good question, especially when you consider that much of the talk leading up to the meeting was pointing toward a normalization of interest rates. I’m sure it was a close call with good supporting arguments on both sides.
On one hand, inflation is not near target and seems to be slipping, so a tighter policy, no matter how small the interest rates might have increased, would have sent a signal to markets that higher rates are on the horizon. Remember that the Fed does not think in current terms; they seek policy directives based on future expectations. Therefore, tighter policy might have damaged emerging markets and derailed some global growth.
On the other hand, wage growth and some price levels have exceeded their 2% target, and perhaps they will approach 2.5-3%, well above the speed limit accepted by the Fed. While we are not near full employment, at some point wage growth will start to have an affect on overall inflation. Should the Fed ignore these gains as they grapple with market volatility? Perhaps the Fed is creating volatility by being too uncertain and cautious and listening to others (IMF) as they plea for the continuation of easy policy rather than sticking to the data.
There was no easy answer for the Fed, and so the waiting – and uncertainty – continues.