Weekend Reading: Yellen Is Paralyzed On The Zero Bound

Janet-Yellen-071416

Janet Yellen, in my opinion, is about to make a critical mistake. She is not going to raise rates in July.

Why is this a mistake? Simple. No matter when you think there will be an economic recession, there will eventually be one. As I have repeatedly stated, the biggest problem for the Federal Reserve has been getting caught at the “zero bound” of interest rates during the onset of a recessionary contraction. Such a combination of events would leave the Fed without a very valuable monetary policy tool.

Come July, Janet Yellen and the FOMC are going to once again “punt” hiking interest rates in favor of waiting for “global instability” due to the “Brexit” to subside. However, as stated this is a mistake for a couple of reasons.

First, with the markets making new all-time highs, there is a “price” cushion available for the markets to absorb a rate hike without breaking important downside support as shown below.

SP500-MarketUpdate-071516

Secondly, with Central Banks globally flooding the markets with liquidity, as discussed yesterday, a further “shock absorber” is currently engaged in softening the impact of a rate hike.

“But, for now, a rash of global Central Banks continue to support asset prices by increasing accommodative policies either through additional reductions in interest rates or direct injections of liquidity. As Matt King from Citi recently noted:

‘It has been a surge in net global central bank asset purchases to their highest level since 2013.’”

Central_bank-liquidity

Lastly, the economy is likely going to show a bit of “strength” in upcoming reports, with slightly stronger inflationary pressures. This pickup in economic strength will be another inventory restocking cycle following several months of weakness. As has been in the past, it will be transient and that strength will evaporate as quickly as it came.

If I was Janet Yellen, I would hike interest rates immediately in a surprise announcement and use the price and Central Bank liquidity cushions to soften the blow. This would move the Fed towards its goals of higher rates and there would be some ability to temporarily control the outcome of the rate hike.

But that is just me. She won’t do it.

Instead, she will pass on hiking rates at the upcoming meeting with promises of rate hikes to come before the end of the year. Unfortunately, for her, this is the “trap.” 

The liquidity will dry up, the inventory restocking cycle will end, and the next “crisis” will be on the horizon with Ms. Yellen remaining stuck near the “zero bound.” 

The past opportunities to “normalize” interest rate policy have come and gone. This opportunity will likely pass also and, as always, the Fed will realize far too late they are trapped. But by then, it won’t matter much to investors, or what’s left of them, anyway.

For now, here is your reading list for the weekend.

“The stock market is like a wife. When you come home you never know if you will be greeted with a kiss, or hit with a frying pan.”  – C. Vern Myers

Fed & Economy

 

Markets

 

My Faves & Raves

 

“Half the plowing is in the planning.”  – Arthur Cutten

Questions, comments, suggestions – please email me.

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Lance Roberts

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report”. Follow Lance on Facebook, Twitter, and Linked-In