For most of the past 10 years the financial markets have been led if not actually directed by the all-knowing, all-seeing Federal Reserve. But over the past year or so the roles have changed, or at least the markets have basically stopped listening to the Fed.
Case in point: Last week the Fed, largely as expected, voted 8-to-1 to raise short-term interest rates by another 25 basis points; Minneapolis Fed President Neel Kashkari, who wanted to keep rates unchanged, was the lone dissenter. The Fed has now raised its benchmark federal funds rate three times since last December.
Normally, that move should have induced long-term rates – which are set by traders and investors in the bond market, not the Fed – to rise, too. But that hasn’t happened. In fact, long-term rates have gone in the other direction, falling to their lowest levels since last November, to the point where the yield curve – the difference between short-term and long-term rates – has flattened out to a point we haven’t seen in years.
Last week the yield on the U.S. Treasury’s benchmark 10-year note ended at 2.15%, which is down nearly 50 basis points from a recent high of 2.63% three months ago. Over that same period, the yield on the three-month T-bill has risen by about 25 bps, from 0.75% to 1.01%. That means the difference between the two has been cut to about 115 bps from 188 bps in just three months.
Why the disconnect between what the Fed is doing, and thinks is happening, and what the bond market perceives is really happening?
The biggest difference in perception seems to surround the jobs market.
As we know, the Fed has two main mandates: price stability – which is usually taken to mean low inflation – and maximum employment. Promoting economic growth is not technically one of the Fed’s legal mandates, but it certainly is in reality, and has been the driving force and goal of Fed policy since the global financial crisis of 2008.
Now, it seems, the Fed has seen to fit to focus on its employment mandate and taken solace in a highly-suspect jobless figure which it is happy to interpret as “maximum employment.” At the same time, it has largely ignored or brushed aside other figures that indicate that the economy just isn’t as rosy as it would like us to believe. But the bond market clearly isn’t buying it.
Over the past few months we’ve had a slew of economic and inflation reports that shows that the economy is a lot weaker than the Fed cares to acknowledge. Consumer buying is down, auto sales have fallen from their peak, housing has hit a wall, and inflation has moderated. Yet, the Fed continues to revert to its mantra about a supposedly “tight” employment market where more than 90 million people of working age are not working and more than a third of adults are not “participating” in the labor market.
At her press conference last Wednesday following its monetary policy meeting, Fed Chair Janet Yellen cautioned that “It’s important not to overreact to a few readings and data on inflation can be noisy.” In other words, let’s ignore what’s happening in the overall economy and focus on an unemployment number – 4.3% in May – that most people who are not professional economists like those on the Fed know it isn’t remotely close to measuring the real rate.
Before last December, you’ll remember, the Fed went nearly 10 years without raising its benchmark federal funds rate because it was fearful, to the point of paralysis, of doing anything that might knock even the slightest whiff of nascent economic growth off the rails. Yet it’s seen fit to raise rates three times since then without consistent growth to back it up, falling back on a phony unemployment number to justify what it is doing.
We have to ask, then: What is the Fed’s real agenda? Why does it appear to be trying to stifle economic growth now rather than trying to promote it, like it used to?
The bond market, however, is having none of it, otherwise the rate on the 10-year T-note should be around 3%, not heading toward 2%.
Yellen’s tenure as Fed chairman was also in the news last week. According to media reports, President Trump has begun considering whether or not he should re-appoint Yellen, whose term as Fed Chair expires in January 2018. Gary Cohn, the former president of Goldman Sachs who is now the chief White House economic advisor, is said to be leading the effort – and may even have his own name on the contender's list.
Based on the Fed’s performance since he was elected last November, the president would do well to pick someone who has at least some sense of economic reality. The current holder of the post appears to have lost hers.
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INO.com Contributor - Fed & Interest Rates
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.