Reaction to the Federal Reserve Policy Statement

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Janet Yellen’s task today was to move the Fed’s goalpost without anyone realizing that she is motivated by weakness in the economy. Her success on that front has been made possible by Wall Street cheerleaders and a largely docile media.

The main problem that the Fed has been facing over the past few months is that the official unemployment rate has been drifting downward towards 6.5%, the level at which it had previously determined would trigger a shift toward monetary tightening. But the rate has been falling not because people are getting jobs, but because people have stopped looking for them. Due to the shrinkage of the labor participation rate, which is the main driver in the falling unemployment numbers, the economy has not received the type of positive momentum that would normally accompany a drift downward in unemployment. As a result, the Fed has to back away from its prior guidance.

As a result, today’s statement completely dropped the reference to the 6.5% threshold. However, if the Fed had acknowledged the real reasons behind the move, investor confidence could have been severely shaken. When you have an economy based on illusion, uttering such truths can be dangerous.

In reality, the Fed will keep manufacturing excuses as to why rates can’t be raised. Whether it’s a cold winter or a hot summer, a geopolitical crisis, or an unexpected sell off in stocks or real estate, the Fed will always find a convenient excuse to postpone tightening. That’s because it has built an economy completely dependent on zero % interest rates. Even the smallest rate shock could be enough to push us into recession. The Fed knows that, and it is hoping to keep the ugly truth hidden.

Although Yellen followed the script on the QE tapering, by decreasing monthly purchases by an additional $10 billion to $55 billion, look for her to abandon her commitment to wind it down to zero just as easily as she has walked back the Fed’s commitment to raise rates once unemployment hits 6.5%. Any additional weaknesses in economic data, or dips in stock or real estate prices, will cause the Fed to call a time out on its tapering plan. Unrestrained by any commitment to sound money or low inflation, look for the Fed to throw open the monetary spigots at the first sign of trouble. However, as the recent raft of higher than expected food prices has shown, such an instinct will hit average Americans squarely in the purse.

 

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