The Fed’s Black Swan

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This CNBC article starts off with the usual pablum about interest rates and how the Fed may decide to hold off beyond next spring given the lack of inflation expectations and effects in the economy. It’s brain melting mainstream media Pap 101.

Fed now expected to stay lower for a lot longer

Really? Ya think? As if its ears were burning here comes my favorite US market related macro chart…

Mark-up of a chart created at SlopeCharts

There is no decision for the Fed to make. They must keep interest rates at ZERO or what has been constructed out of ZIRP ingredients (with periodic injections of QE) is going to come down with a withdrawal of those ingredients.

The article goes on to get a little more intelligent as it considers the view of a rabble rouser named Dick Bove. What he discusses below is in line with the NFTRH view that there are so many pieces in motion now, the world over, that it is impossible to work up traditional market analysis and apply it to traditional forecasting methods. It is in line with what I have been saying since they began phasing out QE3 (as expected), which is that they will not or cannot dare repeal ZIRP, which has been the real policy mechanism at work for 6 years now. Read…

A darker analysis of Fed motives comes from banking analyst Dick Bove, vice president of equity research at Rafferty Capital Markets.

Bove believes the Fed not only won’t raise rates—but also actually can’t hike due to what he calls a central bank “black swan” scenario.

Increases in the money supply and a recovering U.S. economy may make the Fed want to tighten. Reality, Bove said, will step in.

“If the Federal Reserve were to raise interest rates it would cause the dollar to rise even more sharply in value. This would harm the U.S. trade balance causing the deficit to rise even more sharply,” he said in a note. “This would slow domestic economic growth and cause unemployment to rise. Thus, the Fed cannot act no matter what it wishes. This is something that the policymakers may never have considered. It is now their black swan.”

The “black swan” reference is to something improbable but highly significant. Fed critics have been warning for years that it could find itself in a box when it failed to tighten earlier, with an unexpected rise in inflation that forced a faster, sharper series of rate increases the biggest risk.

During the time of extreme Fed easing, inflation stayed low due in large part to the reserves it created and used to buy bonds largely lying fallow in bank coffers.

Much of that time period saw the Fed take the lead among global central banks, easing in terms far greater than any of its counterparts. That dynamic has changed, with Japan in aggressive QE and the European Central Bank expected to launch its own version soon. Bove sees a “currency war” developing that will put the Fed in an uncomfortable position.

“Now, the game is changing. In the past three months the banks have been pulling money out of the Federal Reserve,” Bove said. “They reduced reserves by $234 billion in this period. This money is now in a position where it can be loaned and increase money supply which has grown by $122 billion in this past three months. Therefore, the growth in money supply may accelerate increasing the risk of higher inflation.”

Therein is the Fed’s “black swan,” he added.

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