Fear At The Fed

Share this article

I strongly suspect that Janet Yellen is afraid to pull the trigger on the first rate hike.  Having passed on earlier opportunities to dismantle her debtor-friendly Zero Interest Rate Policy (ZIRP), she has painted herself deeper and deeper into a corner.  Raising short rates will likely lead to rate rises all along the yield curve, adding increasingly to debt service burdens for government, business and households.  And declining bond prices may do serious damage to the Fed’s bloated balance sheet.

IMF Managing Director Christine Lagarde upped the ante recently when she counseled the Fed to defer a first rate increase until at least 2016.  Yellen and her cohorts on the Fed have already demonstrated serious timidity in the face of any negative stock market reactions. Should stock prices fall precipitously after a Fed tightening action, Yellen would rightly be blamed for having facilitated the trauma with a multi-year destructive monetary experiment.  Additionally, her professional credentials would be seriously stained because the IMF would likely be perceived as more foresighted than the Fed.

The Fed’s ZIRP has been misguided from the beginning, bailing out seriously overextended debtors on the backs of savers and taxpayers in general.  Moral hazard runs rampant, and lightweight reforms leave few barriers to a repetition of the past decade’s debt-fueled problems.

It would be no surprise if the Fed were planning to implement a stock market support plan in conjunction with an initial rate rise, whenever that might occur, to erase evidence of a cause and effect relationship.  In fact, I believe the Fed has been actively supporting stock prices at strategic times over the past several years, either directly or–more likely–through surrogates, in pursuit of its goal of increasing the wealth effect.

When the history is ultimately written about the Fed’s misguided effort at economic central planning, there will be plenty of blame to go around.  One unfortunate consequence will be the distortion for years–even decades–of the performance of formerly free stock and bond markets.  I doubt that Janet Yellen fully appreciates the magnitude of the consequences of her past and pending actions; but I believe she hesitates to take the next necessary step because she fears the potentially significant unknown.  Unfortunately, the longer she waits, the more dangerous the ultimate consequences become.