Economy: Something Has Got To Give
July 28, 2016 at 4:25 p.m.
By Gary [email protected]
It was the first time in almost a decade that the Fed raised interest rates. I thought that was really odd.
That’s because if you look back, the historical reasons for the Fed to take that action are not really in play right now.
Normally, the Fed raises rates to cool down an overheated economy or to stave off inflation.
Well, I don’t think anyone looking at GDP growth limping along at an annual rate of 2 percent – 0.7 percent in the Q4 – believes the Fed is worried about an overheated economy.
And inflation has been hovering below 2 percent for the last seven years or so.
So, I wondered, why did the Fed really raise interest rates.
You can’t really tell by what the Fed says. Economists are always trying to read between the lines when Fed chief Janet Yellen speaks.
Back in December, she said the central bank's 0.25 percent hike in its federal funds rate — the percentage that banks charge one another for short-term loans — will be followed only by "gradual adjustments" that can be slowed if economic activity doesn't continue to "expand at a moderate pace."
When I read that back in December, I had an idea of what that really meant. My interpretation was that the Fed was signaling a bit of concern about the economy.
I believe the Fed raised rates because they were at zero. At zero, you have nothing left in your toolbox to hedge against a downturn in the economy.
Hence, the "gradual adjustments" that can be slowed if economic activity doesn't continue to "expand at a moderate pace."
Some Fed watchers took that to mean that the Fed would raise rates again and again – up to four times throughout 2016. The consensus now is that there will be zero rate hikes in 2016.
I believe Fed policymakers never planed on multiple rate hikes this year.
I spoke with several investment-type people whose opinion I respect back in December and ran my theory by them. Most agreed that the Fed likely was hedging against a downturn.
Comes now January 2016 and the lousy aforementioned GDP report.
And reports like this one this week in Reuters:
NEW YORK (Reuters) - U.S. companies are growing more concerned about the prospects of a recession in the year ahead for the first time since the end of the financial crisis.
So far this year, the number of companies whose executives have mentioned recession concerns to analysts and investors is up 33 percent from the same period a year ago; the first such increase since 2009. Some 92 companies have discussed a U.S. recession in their earnings calls, according to Thomson Reuters data.
That gloomy talk highlights worries that growth in the world's largest economy may be coming to a halt. Gross domestic product grew 0.7 percent in the final quarter of 2015, down from 2 percent in the third quarter, while double the number of companies are cutting or flat-lining their capital spending in the year ahead, according to Reuters data. The benchmark S&P 500, a leading indicator of economic strength, had its worst January since 2009 as oil tumbled below $30 a barrel and remained near 12-year lows.
Just this week in Bloomberg, I read an article under the headline “The Fed Wants to Test How Banks Would Handle Negative Rates”:
In its annual stress test for 2016, the Fed said it will assess the resilience of big banks to a number of possible situations, including one where the rate on the three-month U.S. Treasury bill stays below zero for a prolonged period.
"The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities," the central bank said in announcing the stress tests last week.
In that particular simulation, the unemployment rate doubles to 10 percent, the same level it reached in the aftermath of the last financial crisis.
Three-month bill rates have slipped slightly below zero several times in recent years, including in September after the Fed delayed rate liftoff amid global financial market turmoil, touching a low of minus 0.05 percent on Oct. 2.
But in the stress test, banks would have to handle three-month bill rates entering negative territory in the second quarter of 2016, and then falling to negative 0.5 percent and holding there through the first quarter of 2019.
Not a Forecast
"This scenario does not represent a forecast of the Federal Reserve," the central bank said. It also assumes "that the adjustment to negative short-term rates proceeds with no additional financial market disruptions."
Fed officials have made clear that they are a long way from contemplating a reduction in rates below zero in their benchmark overnight policy rate. Some, though, have suggested they’d be more open to such a move than in the past should the economy deteriorate significantly.
This from a Fed that just a little over a month ago actually raised rates.
Don’t get me wrong. I would like nothing more than to see a booming. And I realize there are forces outside our policymakers’ control – record-low oil prices, a slowdown in China’s economy – that adversely affect the U.S. economy.
But I also can’t help but think that there needs to be a fundamental shift in the scope of our own federal government. I have been saying for decades that the larger the government grows, the more difficult it is for the economy to flourish.
My view is that we are playing a zero sum game here. There are only so many dollars. The more dollars gobbled up by the expansion of government, the fewer dollars left in the private sector to grow the economy.
Sometimes I fear that we are reaching the point of no return.
I know things were bad when George W. Bush left office, in large part because of his own expansion of government. But can anyone still argue with a straight face seven years later that Barack Obama’s economic policies are working well?
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It was the first time in almost a decade that the Fed raised interest rates. I thought that was really odd.
That’s because if you look back, the historical reasons for the Fed to take that action are not really in play right now.
Normally, the Fed raises rates to cool down an overheated economy or to stave off inflation.
Well, I don’t think anyone looking at GDP growth limping along at an annual rate of 2 percent – 0.7 percent in the Q4 – believes the Fed is worried about an overheated economy.
And inflation has been hovering below 2 percent for the last seven years or so.
So, I wondered, why did the Fed really raise interest rates.
You can’t really tell by what the Fed says. Economists are always trying to read between the lines when Fed chief Janet Yellen speaks.
Back in December, she said the central bank's 0.25 percent hike in its federal funds rate — the percentage that banks charge one another for short-term loans — will be followed only by "gradual adjustments" that can be slowed if economic activity doesn't continue to "expand at a moderate pace."
When I read that back in December, I had an idea of what that really meant. My interpretation was that the Fed was signaling a bit of concern about the economy.
I believe the Fed raised rates because they were at zero. At zero, you have nothing left in your toolbox to hedge against a downturn in the economy.
Hence, the "gradual adjustments" that can be slowed if economic activity doesn't continue to "expand at a moderate pace."
Some Fed watchers took that to mean that the Fed would raise rates again and again – up to four times throughout 2016. The consensus now is that there will be zero rate hikes in 2016.
I believe Fed policymakers never planed on multiple rate hikes this year.
I spoke with several investment-type people whose opinion I respect back in December and ran my theory by them. Most agreed that the Fed likely was hedging against a downturn.
Comes now January 2016 and the lousy aforementioned GDP report.
And reports like this one this week in Reuters:
NEW YORK (Reuters) - U.S. companies are growing more concerned about the prospects of a recession in the year ahead for the first time since the end of the financial crisis.
So far this year, the number of companies whose executives have mentioned recession concerns to analysts and investors is up 33 percent from the same period a year ago; the first such increase since 2009. Some 92 companies have discussed a U.S. recession in their earnings calls, according to Thomson Reuters data.
That gloomy talk highlights worries that growth in the world's largest economy may be coming to a halt. Gross domestic product grew 0.7 percent in the final quarter of 2015, down from 2 percent in the third quarter, while double the number of companies are cutting or flat-lining their capital spending in the year ahead, according to Reuters data. The benchmark S&P 500, a leading indicator of economic strength, had its worst January since 2009 as oil tumbled below $30 a barrel and remained near 12-year lows.
Just this week in Bloomberg, I read an article under the headline “The Fed Wants to Test How Banks Would Handle Negative Rates”:
In its annual stress test for 2016, the Fed said it will assess the resilience of big banks to a number of possible situations, including one where the rate on the three-month U.S. Treasury bill stays below zero for a prolonged period.
"The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities," the central bank said in announcing the stress tests last week.
In that particular simulation, the unemployment rate doubles to 10 percent, the same level it reached in the aftermath of the last financial crisis.
Three-month bill rates have slipped slightly below zero several times in recent years, including in September after the Fed delayed rate liftoff amid global financial market turmoil, touching a low of minus 0.05 percent on Oct. 2.
But in the stress test, banks would have to handle three-month bill rates entering negative territory in the second quarter of 2016, and then falling to negative 0.5 percent and holding there through the first quarter of 2019.
Not a Forecast
"This scenario does not represent a forecast of the Federal Reserve," the central bank said. It also assumes "that the adjustment to negative short-term rates proceeds with no additional financial market disruptions."
Fed officials have made clear that they are a long way from contemplating a reduction in rates below zero in their benchmark overnight policy rate. Some, though, have suggested they’d be more open to such a move than in the past should the economy deteriorate significantly.
This from a Fed that just a little over a month ago actually raised rates.
Don’t get me wrong. I would like nothing more than to see a booming. And I realize there are forces outside our policymakers’ control – record-low oil prices, a slowdown in China’s economy – that adversely affect the U.S. economy.
But I also can’t help but think that there needs to be a fundamental shift in the scope of our own federal government. I have been saying for decades that the larger the government grows, the more difficult it is for the economy to flourish.
My view is that we are playing a zero sum game here. There are only so many dollars. The more dollars gobbled up by the expansion of government, the fewer dollars left in the private sector to grow the economy.
Sometimes I fear that we are reaching the point of no return.
I know things were bad when George W. Bush left office, in large part because of his own expansion of government. But can anyone still argue with a straight face seven years later that Barack Obama’s economic policies are working well?
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