Why you shouldn’t fret over the Fed's decisions

Central banks react more than they play a causative role, with economic and market conditions driving their decisions

The Fed raised interest rates by 75 basis points four times this year despite chairman Jerome Powell's reassurances in May. Reuters
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All eyes fixate on the Fed! Commentators, economists and headlines twitch whenever America’s Federal Reserve wiggles.

They focus myopically on Fed projections and policy decisions — searching for clues about the central bank’s future gyrations and how global economies and stocks will react.

But it is all heavily overblown. Fed actions are cheap. Its talk is even cheaper.

The widely held presumption: that America’s central bank — with its army of doctorate holders and institutionalised processes — must be wiser than the collective marketplace, with a keen eye for the US economy’s future and the power to steer it, as needed.

Hence, conventionality envisions Fed talk as prescriptive and its policy moves as critical.

Wrong! I have long written that central banks are given more to reacting than playing a causative role — economic and market conditions drive their decisions, not the reverse.

Why? Widely held economic expectations — such as inflation driving up long rates — are pre-priced. Furthermore, with its dozens of similarly trained economists on staff, Fed talk amounts to groupthink writ large — rarely deviating from consensus views. Its forecasts shift with popular thinking.

Consider “forward guidance” — the Fed’s telegraphing of coming policy moves.

Central bank jawboning and forecasting don’t prevent surprises and volatility. Instead, they often create chaos when decisions or forecasts vary from prior guidance, which is common.

This raises uncertainty, weighs on sentiment and curtails risk taking. Everyone makes wrong forecasts, me included.

But forward guidance cements them into policy expectations, so switching gears draws the public’s ire.

Hot 2022 inflation exposed forward guidance as folly. Even before Russia invaded Ukraine, American inflation was rising sharply. The Fed said not to worry. It was fleeting — “transitory”.

It abandoned that stance suddenly in March, fanning the rate increase fear partially behind 2022’s global bear market.

In December 2021, the Fed said rates would end 2022 at 0.9 per cent. Yet rates will actually end at 4.5 per cent.

Fact: In May, Fed Chairman Jerome Powell said officials weren’t even considering 75 basis point increments. Astoundingly, it raised interest rates by that much at each of the next four meetings!

Then Mr Powell implied forward guidance itself would end last July — only for every policymaker on its board to start jabbering again days later.

If the Fed doesn’t know what it will do next, how can you?

This isn’t new. Take America’s 2012-2014 “unemployment threshold” saga.

In December 2012, the Fed said Fed fund rates would stay “exceptionally low … at least as long as the unemployment rate remains above 6.5 per cent …”

Six months later, it stressed 6.5 per cent was a threshold, not a trigger.

In September 2013, it called the 7.2 per cent jobless rate of the time “not necessarily a great measure” of the labour market.

By March 2014, the Fed scrapped the unemployment threshold altogether — as it sat at 6.7 per cent.

Now, the Fed claims it must raise interest rates higher and longer than initially planned to curb inflation, stirring investor hand-wringing and chatter.

At their December meeting, Fed officials predicted three quarters of a point more in 2023 rate increases — bringing the “terminal rate” to 5.1 per cent.

That is higher than the 4.6 per cent rate the Fed predicted in September, frightening many. But why believe them?

Regardless, don’t its actions largely control the economy? Don’t bank on it.

Perversely, 2022’s rate hikes show this. Rate hikes conventionally impact growth by raising banks’ short-term funding costs, theoretically cooling lending, thereby impeding growth.

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Lose your Fed fixation and don’t buy their tough talk on inflation. Instead, see falling input costs, improving supply chain functioning and lower inflation expectations
Ken Fisher, founder, executive chairman and co-chief investment officer of Fisher Investments

Banks borrow short term — from each other overnight or from the public via deposit accounts — to fund longer-term loans.

But, as I briefly discussed on December 5, banks are now awash in low-cost deposits. They needn’t borrow from one another or compete for more deposits with higher rates.

They get all they want at virtually zero cost. Deposits’ share of bank liabilities is historically high and total deposits are about 35 per cent above pre-coronavirus levels.

Hence, lending is more profitable. No shock, then, it accelerated in 2022 despite 4.25 percentage points of rate increases.

The Fed isn’t alone here. Numerous about-turns crushed former Bank of England boss Mark Carney’s credibility — in 2014, one Member of Parliament compared him to an “unreliable boyfriend”.

Mr Carney’s successor Andrew Bailey received the same moniker in 2021 after reversing course on an expected increase.

More recently, the Bank of Japan’s shocking yield curve control pivot undercut faith in Governor Haruhiko Kuroda’s longtime jawboning to the contrary.

Regardless, Japanese 10-year yields rose by only 0.2 percentage points afterwards.

So, lose your Fed fixation and don’t buy their tough talk on inflation.

Instead, see falling input costs, improving supply chain functioning and lower inflation expectations, which already have long rates off their highs.

That, against a resilient economy the Fed can’t comprehend, is a recipe for market recovery.

Ken Fisher is the founder, executive chairman and co-chief investment officer of Fisher Investments, a global investment adviser with $160 billion of assets under management

Updated: January 03, 2023, 4:45 AM