The Omnipotent Fed

“Sometimes what you want and what you get are two totally opposite things.” In that statement lies the seed of the Federal Reserve’s conundrum. It also is the basis for a proposition that the GROUP– the politicians, economists, main stream media, and the investing public in general, have difficulty coming to grips with.

The fed is not omnipotent. Contrary to the strategy set out, by that small group who gathered on Jekyll Island in 1910, ultimate control of the financial markets by the Fed has always seemed illusory at best. That is not to say that the 1910 gathering was not successful for themselves , their colleagues and their 1{82ede2586bb1c0d1ebd6b8982c31d283462d3416f86f3759028bb4258e074613} class. It most assuredly has been. Ultimate control of any market, however, always lies with the market itself, a fact which has continued to elude every Fed board since inception. Any investor, however, would have been wise to heed the old adage “don’t fight the Fed.” Currently and historically, the Fed would have been wise to rephrase the statement for itself into “don’t fight the market.”

The lack of economic and simple financial understanding by the GROUP is almost mind boggling. I hear on radio, see on television and read on the internet all those urging me to act now to get a mortgage, buy a car, expand my business and, most assuredly, get out of the Treasury market. “The rates going up makes money more expensive and Treasuries less valuable. Yes, the Fed,” they say, “will be raising the rates and unwinding their balance sheet.” “ Take heed, take heed,” the GROUP has warned.

I would be inclined to immerse myself in the GROUP if it wasn’t for two little overlooked facts. First, rates are both long term and short term. Second, the Fed controls the short term rate and hopes to influence the long term rates. That is the Fed’s conundrum and the GROUP’S misunderstanding, the lack of the long term Treasury participants doing what they should be doing.

The premise goes like this. If the Fed is raising rates (short term) it is to get ahead of the dreaded hyper-inflation that is, most assuredly, just around the corner. Growth will be surging at such an uncontrollable pace that the Fed will have found itself behind the curve and out of control. Countries, other central banks, hedge funds, pensions, traders and investors of all kinds will follow the Fed’s wisdom and will act accordingly. After all the Federal Reserve has all of the REAL economic data to base their strategy on. In addition they have the smartest strategic minds and are led by the most experienced and nonpolitical financial wizards that this country has produced. How can they not be omnipotent and not worth following? That is the question that the Fed is asking itself today. Its expectation was that the long rate (10 year) would rise as the bonds were sold at almost a break neck speed and the yield curve would so reflect. This most certainly had to happen.

Alas, “sometimes what you want and what you get are two totally opposite things.”

For the past few months the Treasury market has viewed the future a bit differently from the Fed. Where the Fed sees growth the Treasury market sees stagnation. Where the Fed sees political success for the party in power the Treasury market sees only turmoil and vacant promises. The Fed has said a new day but the Treasuries have said just more of the same.

The so-called smartest and brightest, most experienced and most financial wizardly are leading but the long end is not following. The fed continues to be mired in the Keynesian web of inflation hope, located somewhere in the not too distant future. The Treasury market, however, has recognized that the 800 lb. gorilla called Deflation has not yet left the room.

With the ten year approaching a one handle and the Chinese once again becoming an aggressive buyer it would behoove any investor to step away from the GROUP and come to the realization that it is the market that is ultimately omnipotent and not the Fed.

Written by
With his passion for economics Bill Tatro has been entertaining audiences on the radio and in seminars for decades. Bill is an economist that provides weekly paid content to subscribers, and offers a free daily "lite" version as well.