Tuesday, September 20, 2016

The reason the Fed won’t raise rates tomorrow

For many decades, the Fed would raise the Federal Funds rate when the 1 year Treasury rate got 50 basis points or more from the Federal Funds rate.

The 1 year rate leads the Federal Funds rate, up or down.  Yet the Fed takes credit for interest rates.  The 1 year rate is a market rate.  When the Fed has let the 1 year market rate stay too high above the Fed Funds rate too long, a boom is created by the money supply being increased too much more than the demand for money.

When the Fed has let the 1 year rate stay too low below the Fed Funds rate for too long, an economic contraction is created.  This is because there isn’t enough money to meet the demand for money.

The last time the Fed raised rates December 16, 2015, the spread between the 1 year and the Fed Funds got to a high of .58 points on December 11th, just before their meeting.  They had to move.

Now the spread is only .10 points so they don’t need to raise rates.  The chart is the 1 year interest rate minus the Fed Funds interest rates.

{click to enlarge}

Aren’t you sick of hearing the Fed constantly talk about raising rates?  It is a communications transmission thing.   They are trying to talk up the market rate of interest so they can follow it up.  Why?

It is inflation.  It is the wealth effect.  The only single thing the Fed cares about is the wealth effect.  Nothing else matters.  Not unemployment or any other economic indicators.  And inflation is the way to get more wealth effect.  How?

Inflation causes interest rates to rise.  So the want to raise rates to push up inflation.  The cart before the horse.  They can't raise rates without the market rate going up first as show above.  So they try to talk up the market interest rate.

I believe that when the FOMC meeting opened on December 15, 2015 they had already over the weekend called the necessary voting members and made the decision then.  The minutes are show.

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