We can all take heart that the Fed is still supporting the global markets. But if the message of the market is any indication, then this may be the wrong approach. I suspect this was a contentious meeting, the committee struggling with a pivot to tighter policy. Simply put, the current funds rate near zero has been in place for more than six years, and while the recovery is not anything hoped for, extremely generous policy has passed its time. The market remains confused by policy that seems to have the Fed boxed in.
Markets balked at the removal (taper) of QE back in 2013 into 2014, yet at the end of the day it was the right thing and markets responded positively. Let’s take a closer look at this. The announcement in October 2013 was the Fed would start removing the generous 85 billion a month QE by 10 billion a month. The initial reaction was a pop in volatility and drop in the stock market, but finished the year higher by 10%! The VIX went to 20 and right back into the low teens. With some clarity and uncertainty removed the markets eventually responded positively.
This should have been the model followed by the Fed this time around. The ‘taper tantrum’ often talked about in 2014 was a non-event. The stock market rose in 2014 in the face of tapering and when it ended a year later (October 2014), the SPX 500 was up more than 12%. The market drop (nearly 9.4%) due to ebola was far worse than any news brought by the Fed.
So, why didn’t the Fed move this time around? That’s a good question, considering much of the talk leading up to the meeting was pointing toward starting the normalization of interest rates. I’m sure it was a close call with good supporting arguments on both sides. This meeting was a great opportunity to get rates back onto a normal path, but they seemed to be frozen by perceived global turmoil. Inflation is not near target and seems to be slipping, a tighter policy, no matter how small the rise sends a signal to markets that higher rates are on the horizon. Let’s understand the Fed does not think in current terms, rather they seek policy directives based on future expectations. Nothing in the future is certain, but the best minds we have on the committee must make the best decisions for all. Simply put, tighter policy might have damaged emerging markets and derailed some global growth.
On the other hand, wage growth and some price levels have exceeded their 2% target, and perhaps will approach 2.5-3%, well above the speed limit accepted by the Fed. While not near full employment (large amount of workers out of the labor force), at some point wage growth will start to have an affect on overall inflation. Should the Fed ignore these gains as they grapple with market volatility? Perhaps the Fed is creating the volatility by showing uncertainty and too much caution, listening to other pleas for keeping easy policy (IMF, others) rather than sticking to the data.