The Fed’s Next Surprise Move


The Federal Reserve seems to have been caught off-guard by the recent turmoil on the markets. As the Chinese economic growth seems to be slowing down, all of the Western central banks need to re-think their plans, and the Federal Reserve will have to kneel in the dust.

Whereas just a few weeks ago, the Fed ‘promised’ the markets it would increase the interest rates 4 times in just twelve months, the central bank is already reneging on its promise as it no longer thinks it will be able to do so without completely suffocating the economy. As we explained in a previous column, the use of some specific words when the original rate hike was announced indicated to us the Fed was actually anticipating the markets might not be ready for more rate hikes just yet.

This has now been confirmed by Robert Kaplan, the president of the Dallas Fed. In one of the most recent statements of the Federal Reserve, the central bank has no longer used the word ‘balanced’ to describe the potential risks to the US economy, and Kaplan has now confirmed this was caused by the bank no longer willing to trust its own expectations and projections.

The implications of this news, you ask? Well, they are huge. First of all it does indicate the American economy (and the world economy) is in a worse shape than one would have anticipated. The muscle-flexing of the Federal Reserve is now really blowing up in their own faces. This updated view was obviously also influenced by the Bank of Japan which has now introduced a NIRP. A Negative Interest Rate Policy.

Bank of Japan interest rate


That’s absolutely unheard of for any central bank in a civilized country, and Japan seems to be desperate to try to get its economy going again, even though the interest rates have been low for the past few decades. As you can see on the previous image, Japan has had an interest rate close to zero for the past 20 years, and that hasn’t helped the country too much. That’s also one of the main reasons why we didn’t expect the zero interest rate policy of the Federal Reserve to be very helpful.

Federal Reserve Fed 10Y Note

Source: Yahoo Finance

Indeed, the market had lost its faith in the Federal Reserve earlier this year. Even though the central bank was still pretending it would be able to increase the interest rates by no less than four times in 2016, the yield on the 10 year treasury notes continued to fall (which would actually indicate the market participants were expecting the interest rate of the Federal Reserve to decrease rather than seeing it hiked).

CME Group Pic

Source: CME Group

The new wording in the press release of the Federal Reserve as well as the sudden move by Bank of Japan has rattled the futures market of the 30 day funds rate, and it now looks like the market is right now assigning a possibility of just 80% to see just one rate hike (of 0.25%) this year. This basically means Mr Market has now given up on expecting the federal reserve to increase the interest rates this year. They tried but failed (miserably).

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