A couple weeks ago the Bank of Japan made a startling move when it pushed a key interest rate into negative territory. After one of its officials had said just a week prior that the central bank wasn’t considering this option, the world was needless to say a little stunned.
Now there’s a lot of speculation on whether the bank was planning it all along. And of course the speculation has filtered its way over here with everyone wondering now whether the Fed will raise rates in March, June, or not at all. Many are now wondering whether the Fed will go negative as well.
But speculation’s not really my thing. We can spend hours talking in circles about what the Fed will do and when. Everyone seems to get all worked up about what the group says to get an idea toward future policy. What is important, though, is having an idea about how the market will react.
Don’t get me wrong, I’m always hopeful the Fed will say something interesting when they release their policy statement, although it’s usually pretty mundane… even boring. But what they say and do can have a huge impact on the market, so it pays to listen.
Since last month’s Fed meeting was the first of the year, I want to give you a little background on the organization that seems to hold so much influence over the direction of the economy.
Most of it is pretty cut and dry. The Federal Open Market Committee (FOMC) meets about eight times a year to discuss policy.
The committee consists of 12 voting members, eight of which don’t change, while the remaining four rotate among the Fed’s regional banks. They meet behind closed doors, and at the end release a policy statement and usually talk it out with the press.
But every now and then, the Fed holds an unscheduled policy meeting. The last time was March 4, 2014 before their regularly scheduled meeting was held two weeks later. The unscheduled meetings themselves aren’t that big of a deal. But it gives you an idea of just how careful the group is with everything they say.
Back then, everyone was still wondering when the Fed would lift rates off zero, and since unemployment was near their target of 6.5% unemployment, they had to say something.
In this case, they didn’t want to shake up the financial markets by leaving everyone to believe that a rate hike was imminent. So they met to discuss what to do with their policy language.
If you look in the minutes from that meeting, one participant wanted to stress the importance of referencing “financial conditions” instead of “financial stability.” The idea was to make it as clear as possible that factors beyond monetary policy, which is the Fed’s wheelhouse, could influence financial conditions.
If you’re wondering why all the fuss over a word, you’re asking the right question.
Ever since the Fed took up the mantle of patching over the economy’s problems under the leadership of former chair Ben Bernanke, the Fed has become as much a political organization as an economic one.
So, these dozen or so masters of the universe spend a lot of time getting the wording just right in their policy statements. They don’t want to communicate panic or joy because investors will certainly overreact! I guess their job is just to try and remain credible and keep the financial system relatively calm.
I’m not sure if the Fed has gained or lost credibility over the last 10 years. But ever since they let the genie out of the bottle by papering the landscape with quantitative easing, they sure have gained power.
In fact, central banks around the world are manipulating their currencies and trying to prop up their economies by using the same tactics that didn’t work here.
But just because central bank stimulus doesn’t actually improve the economy – just patch things over – the markets are addicted to it!
What’s interesting is that in the Fed’s last meeting, there was no mention of quantitative easing. I guess they figured out that policy has run out of juice. The talk has turned to negative interest rates, which now seems to be the policy tool of the day.
It’s likely the Fed could implement a negative interest rate policy in the future. In fact, they have already discussed the possibility. But the Fed stressed that it would take a severe global recession, unemployment at 10%, a 50% drop in stock prices, another 25% plunge in real estate prices, mounting credit losses, etc. before resorting to this tactic.
Not that they’re expecting that or anything…
Editor, Treasury Profits Accelerator