Friday, October 14, 2016

Raising Rates as the Economy Slips Into Recession

It is always a paradox why government policy tends to be so uniformly pernicious.  We are about to see another example of that.

Third quarter data shows that bank commercial lending fell for the first time in six years.  Given other data, there is a very strong likelihood that the sluggish economy is about to weaken into recession territory.  Perfect time for a rate hike?  Club the economy on the way down?  Is that the idea?

But, that is exactly what is about to happen.  And the reason?  The Fed does not want to appear irrelevant.  All other interest rates have been rising over the past couple of months.  Only the repo rate and the funds rate have not been rising.  Those are the only two rates that the Fed has any possibility of controlling (and, frankly, only by completely artificial methods).

Gone are the days when anybody believes that the Fed can loosen or tighten.  Having a $ 4 trillion balance sheet does not leave much room for flexibility.

So, we are about to see an interesting spectacle.  The Fed will act to "raise rates," while the economy weakens.  Good combination.  Is that what they teach in Macroeconomics these days?  Raise rates just as the economy weakens?

The absurdity of Fed policy as well as the bankruptcy of modern academic Macroeconomics is just about to be put on sharp display.

No rational person believes that a policy of raising rates coincident with a falling economy is sensible policy.  Only Janet Yellen and other "political" economists can defend what they are about to do.

But, if they don't do it, the Fed will be exposed as irrelevant.  The Fed is irrelevant, but they desperately do not want that fact revealed to the public.

Thus, look for the Fed to "raise rates" while the data shows the economy is weakening.  Interesting and ridiculous policy, but perfectly predictable.

Goodbye stock market.

You might wonder:  why other rates are rising?  Because the long dormant inflation is beginning to rear its head. That will move all rates higher regardless of whether or not there is a Fed or what it may or may not be doing.

Yes, inflation can pick up exactly at the time the economy is faltering.  Does anyone remember the 1970s and "stagflation." That's where we are headed.

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