There's a Fine, Fine Line By: Gabriel PotterMBA, AIFA® 2016.09.14

Here’s an annoying cycle that has been playing out for the past few weeks.  Earnings reports and other fundamental measures of economic growth are low, but stable and positive.  The markets go up.  Against this backdrop, it becomes harder for the Fed to justify continued low rates, so a member of the FOMC will suggest a rate hike in September.  When borrowing money gets more expensive, growth gets muted and markets go down.  Against this backdrop, it’s harder for the Fed to increase rates, so the odds of a rate hike drops in September.  Oh good, so continued cheap money, and the markets improve again. 

And this cycle goes on and on.  All of it based on speculation.  None of it based on economic fundamentals. 

There’s a fine line between using monetary policy, tightening or loosening, to mitigate true economic fundamental overreactions and technical, market driven cyclicality.  We seem to have crossed it.  Markets seem to be driving expectations of a Fed rate hike more than economic fundamentals, and that is a mistake. 

Let’s accept that there is a range of possibilities – from deep depression to jolting, booming growth.  Let’s also accept that we are in the middle of that range – basically fine.  Let us also posit that there is a range of possible monetary policies, from very loose to very tight.  The current monetary policy is unquestionably still very accommodative – very loose.  Adding the two concepts together, within the range of expectations of fundamental economic conditions, there should be a corresponding range of monetary reactions. The truth is that the economy is simply not bad enough to justify keeping rates this low, this long.

 

 

 

 

 

 

 

 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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