Monday, March 2, 2015

Fed Ushers in a New Era of Uncertainty on Rates

Jon Hilsenthrath, who covers the Fed for WSJ, and thus gets a strong insider take on Fed thinking, writes:

Investors these days are obsessing over when the Federal Reserve will start raising short-term interest rates. Drawing less scrutiny is where rates will end up in the long run and how they’ll get there. But it’s time to start paying attention.

Fed officials have made clear they expect to begin raising short-term interest rates from near-zero this year, though not before midyear. After that, there is great uncertainty at the central bank and in the markets about the future path of interest rates...

 Fed Vice Chairman Stanley Fischer said there that market expectations might move—perhaps abruptly—closer to the Fed’s when the central bank starts lifting rates. A first increase “will add to the credibility of what we’re saying,” he said in a not-so-subtle warning to investors who doubt the Fed’s plans...

Fed officials estimate this long-run rate is now around 3.75%, which amounts to 2 percentage points as compensation for inflation and a 1.75-percentage-point real return on investment. Their forecasts suggest they effectively see themselves getting close to this equilibrium rate by the end of 2017...

Given all the uncertainties about growth and inflation, Fed officials will have to feel around for the right long-run interest rate like a person in the dark.

“I don’t think that is a question we can answer right now,” Mr. Fischer said of the long-run rate.

The uncertainty means an important change in central-bank tactics is coming. For a decade now, Fed officials have used various ways to give investors “forward guidance” about where interest rates are going.

In their latest guidance, Fed officials said they would be “patient” before starting to raise rates, meaning no rate increase is likely at their next two policy meetings. They are now moving away from this guidance.

It appears investors are going to find themselves doing a lot of guesswork about the path of rates after they start rising this year, along with the Fed itself.
What's remarkable about Hilsenrath's take is that many believe that the Fed won't anytime, in the next couple of years, even raise rates to the 3.75% level.

In the EPJ Daily Alert, I am warning that price inflation will start to accelerate much faster than almost everyone expects (most likely in the second half of 2105) and that the Fed will raise rates much more aggressively than 3.75% by 2017, but still will remain far behind in fighting the developing price inflation.



  1. Robert,

    How do you see Washington servicing the existing debt and managing future deficits if the Fed raises rates? It would appear that simply raising taxes would not be enough and Congress has shown that it does not have the political will too cut any spending.

    Could you also talk about the derivative market, which is over $250 trillion in interest rate derivatives,and how it would be managed. Even with bilateral netting there is a huge problem, namely that it relies upon an orderly collapse and all contracts to be honored by the issuing bank.

    Thanks for the response.


  2. The Craven Failure of the 'Technocrats' at the Fed

    I see where Mr. Bernanke thinks that Presidents should be given extraordinary powers to declare 'financial emergencies' and 'not leave it all up to the Fed.'

    And who is it that doesn't want to be audited, doesn't want anyone looking over their shoulder, wants to be free to exercise their independent judgement, and keeps raising their hands to be given more and more regulatory powers which they fail to exercise faithfully and objectively over their banking cronies.

    And then when they blow up the economy with a financial bubble which they created, they want the nation to clean up their mess, presumably by having the President invoke special emergency powers so that their financial engineering prowess is not encumbered by the democratic rule of law as they continue to throw trillions of dollars at the aftermath of the collapse of financial bubbles for which they have been the chief architects.