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Fed Says it Will be Patient in Raising Interest Rates

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The Open Market Committee of the Federal Reserve System finished up its two-day meeting on Wednesday and basically said that it was not anxious to do much of anything for the near term in terms of raising short-term interest rates.

The Fed is quoted as saying that it will be patient in raising interest rates.

The Fed mentioned “patient” and the stock market dropped.  The S&P 500 stock index closed down by a little more than 28 points after being up as much as 10 points earlier in the day.   The Dow Jones Index dropped by almost 196 points.

The victor was the bond market where bond prices rose dramatically letting the yield on the 10-year US Treasury note fall to 1.72 percent, the lowest it has been since early May 2013.

Behind this threat of action, or, threat of no action, the Federal Reserve statement presented the “most upbeat” economic outlook since the end of the Great Recession although it did not seem to anticipate much inflation in the future.

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What can one read into this news from the Federal Reserve?

My feeling is that the Federal Reserve is afraid to indicate it might raise short-term interest rates because of the recent increases in the value of the US dollar against most foreign currencies.

Why is that?

Well, if the Federal Reserve said that it was definitely looking to raise short-term interest rates in this summer and said this with a strongly worded press release, the value of the US dollar would probably have gone much higher than it did.

The value of the US dollar as captured by the US Dollar Index published by the Wall Street Journal still did rise on Wednesday reaching a level it has not seen since May 2013.

The Federal Reserve, I believe, feels that it must be very careful about signaling an increase in short-term interest rates because most other currency areas are experiencing government policies that are attempting to reduce the value of their currencies.

This has been the main thing that has contributed to the strength of the US dollar.

If market investors believed that the Fed was going to raise short-term rates that would just exacerbate the situation because that action would make the position of the United States dollar relatively stronger.

And, why doesn’t the Fed want to add more reasons for the US dollar to rise in foreign exchange markets?

Well, look at the headlines from the Wednesday morning papers.  On the Wall Street Journal we read “Strong Dollar Squeezes U. S. Firms.”  On the Financial Times we read “Strong Dollar Weighs on US Results.”

In other words, United States companies are already being hit by last years’ rise in the dollar.  And, the impact is expected to grow.

There is a real possibility that United States growth might be impacted by the rise in the value of the dollar.  This would take the “improved” forecast of the Fed and bring the US  growth rate down to mediorce again.

The Federal Reserve is in a real bind now.  It has pumped trillions of dollars into the banking system that are not being used right now.  It’s policy rate, the effective federal funds rate remains around 12 to 13 basis points.  And, loan demand remains tepid.

Yet, the Fed is afraid to keep things this way, because this situation is “not normal.”  But, the Fed doesn’t seem to want a US dollar that is stronger than it is right now.

So, for the time being, the officials at the Fed are waffling.  It appears as if they don’t want to do anything that will strengthen the US dollar any further.  And, they don’t want to do anything that will make the US dollar weaker.

This situation is in addition to the dilemma they have been dealing with over the past three months.  The banking system has too many excess reserves and some of the excess reserves need to be removed from the banking system so that short-term interest rates might be made to rise.  But, the Fed does not want to remove reserves from the banking system that the banks desire to maintain their health and solvency.

Officials at the Federal Reserve are facing many conflicting demands on them right now.  What they do in the future, I believe, will impact all of us.

About John Mason John MasonJohn has been the President and CEO of two publicly traded financial institutions and an Executive Vice President and CFO of a third. He has also spent time as an economist in the Federal Reserve System and worked for a cabinet secretary in Washington, D. C. In addition John taught in the Finance Department at the Wharton School of the University of Pennsylvania for ten years. He now currently has a column on the blog Seeking Alpha and is ranked number 3 in terms of readers on the economy. From this column, two books have been published this past year from earlier blog posts. John is active in the shadow banking world, the venture capital space, and in angel investing. Other than that John works with start ups and early stage organizations, for profit and not-for-profit.

 

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