Does this seem crazy to you? What if I told you the Fed themselves know it?
The reality is the US Federal Reserve does not control interest rates. It is also true that the same situation is seen by other central banks around the world.
Before getting to that, it is amazing to watch the world hanging on edge as the Fed announced their policy this week. It is as if they are at the center of the universe and nothing is going to happen without them.
We heard from Chair Powell that they are going to accelerate their taper until it ends in March. At the time, if economic conditions warrant, they will begin to raise interest rates. The goal is, perhaps, three rate hikes next year.
Yawn.
Why do people believe this nonsense?
Source
Correlation is Zero
Many believe the Fed is in control of things. This is exactly what they want you to believe. In essence, the Fed manages expectations, that is all. Outside of that, they have very little power other than the fact people buying into what they spew.
In other words, they are running a grand ruse and have been doing so for a long time.
The Fed wants you to believe they print money. This is one of the tools in their arsenal. If they make people think they can expand and contract the money supply through their QE and QT programs, then they can claim victory when things happen like they say.
Unfortunately, as shown in There Is No Printing Of The USD, the Fed does not create US Dollars. That is tasked to the commercial banking system and the Fed is powerless in making them lend. If banks do not want to lend, the Fed is screwed.
This brings us to the other area the Fed supposedly controls: interest rates.
We hear a lot of speculation whether the Fed will raise or lower interest rates. This is a major topic of discussion on the financial media channels. They spend a lot of time talking about something the Fed admits it has no control over.
Here we have research that was posted on the website for the St. Louis Fed relating to Greenspan's Conondrum:
During his February 2005 congressional testimony, Alan Greenspan noted that despite the fact that the Federal Open Market Committee (FOMC) had increased the federal funds rate 150 basis points since June 2004, the 10-year Treasury yield remained essentially unchanged. He posited several possible explanations for what he believed was the aberrant behavior of long-term Treasury yields. Rejecting each in turn, he called it a conundrum.
Thornton (2018) took a different approach. Rather than assuming the conundrum began at about the time Greenspan observed it, he investigated when it began. He found that the relationship between the 10-year Treasury yield and the federal funds rate changed in the late 1980s, with the most likely date being May 1988. Based on previous research, he hypothesized that the change in behavior occurred when the FOMC began using the federal funds rate as its policy instrument. Once the FOMC began this practice, the federal funds rate moved only when the FOMC changed its target for it. In contrast, the 10-year Treasury yield continued to respond to news as before.
Here is the kicker:
The correlation between the federal funds rate and the 10-year Treasury yield declined to zero.
This is from the St. Louis Fed's own website.
Even they are saying there is ZERO correlation between the Fed Funds Rate (which the Fed can raise or lower) and the 10-Year Bond, the benchmark for the entire debt market. If there is zero correlation, why do people pay any attention?
Managing Expectations
The Fed cannot have people believing that it goes around doing nothing. Hence, since it has no impact upon monetary policy, perhaps it can excel at public relations. This is exactly what it does.
Repeatedly I gave Chairman Powell credit stating that he knows how to play the game. He is also very adept at understanding the situation. Even in this weeks announcement, the door was left open for them not to raise rates, or at least reduce the number. Notice no confirmation was given based upon economic conditions.
It does not take a genius to understand that Powell has the choice between inflation and the economy. He knows that the former is transitory. Thus, if he can act like they are doing something, the Fed can take credit when the inflation falls.
How can I be so sure that inflation will fall? Simple. The global economy is going to suffer a major pullback. We are already seeing the warning signs. Hence, Powell knows that he cannot step in front of that. There is nothing they can do to keep the economy afloat.
So, in reality, the choice is between inflation and the market. He might be able to thread a needle by convincing markets they are in control of the situation. After all, he is giving them exactly what they want. Everyone from Wall Street to Congress to the talking heads on the financial channels wants the Fed to do something. Powell was listening knowing that all those parties pretty much have no idea what they are talking about. Nevertheless, he cannot take them head on.
The Fed can do nothing about the long end of the yield curve. It also is powerless over the LIBOR yield curve. Since they are both saying the same thing, Powell is really backed into a corner. The economy is on weak ground and both are screaming it. So while Powell has to appease the participants in the market, both markets are telling him that inflation is not going to be a problem.
What is the major problem is the economic headwinds.
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