It’s good to be back writing something after a long while.
Better late than never, they say J.
The Fed’s delayed hike has been
causing some stir in the markets recently. The markets expecting a rate hike in
this year, were largely caught wrong footed by dovish Fed as the year draws to
a close. Despite encouraging data –on average- the Fed’s caution draws a lot
from mix of external as well as internal factors. The markets seem to have
become self-aware, causing a volatility
in betting on Fed’s first hike as the
Fed remains muted and largely vague in their decision about selecting and
conveying the.
What are the reasons behind it? There
may be many, but my two cents say that Fed itself is responsible for this
confusion among the markets. How do I
believe so? This goes back months when I was listening to the interview of a US
Navy Pilot describing his aircraft “departing” or losing control and stalling. His
reaction was,” If I’d try to fight the situation by increasing the throttle, I’d
only had ended up making it worse. So I just put my hands in the lap and enjoyed
the ride until the aircraft stabilized”. Similar was the case with most of the
central banks when the emergence of The
Great Recession tested the policy innovation capacity of the central banks in
developed world. From rate cuts to various forms of QE, every central bank did
what it could do so i.e. take a shot in the dark and hope for a bullseye. It
was largely because
1.
Central Banks didn’t completely know the extent
of the crisis.
2.
And they couldn't fight the crisis with
conventional wisdom.
So the just like a fireman not
knowing which rooms are on fire, they took the safest bet i.e. covering the whole
building with water cannons and rolled out very large QE programs. Equally
important alongside firefighting was rescue job. The Central Banks were not
only to fight the crisis but also tag markets along. And since the economy was
like the plane of Naval aviator, they did what they could do best i.e. wait and
see,
Resultantly, the central banks
became data dependent in their outlook because
1. It
lent more transparency to central bank’s decision in the time of great
uncertainty.
2. It
took the burden off the Central Banks and gave markets a benchmark for recovery.
The strategy worked well for good
period of time as the recession retreated and recover started to take place.
However, there was a key shortcoming in adopting this strategy i.e. data’s inability
to be used as a policy tool e.g. Interest rates, Reserve Requirements etc. It’s
just like a turkey hunter putting one’s gun on a random shooting machine. The
shooter is indifferent in night as the both would aim almost equally effectively.
But as the day approaches and hunter sees turkeys moving around, the random gun
shooting machine spoils his chances of shooting more accurately by himself.
Likewise, the policy of remaining data dependence may have worked exceptionally
well during the days of the crisis but it may do more harm than good in the
days when there’s a greater extent of certainty around. In addition, this data paradigm is strictly
engulfing the market thinking i.e. The data will drive the Central Bank. Result
is a rapid plunge in rate hike expectations as soon as the two NFP numbers came
below expectations. Also, if Fed
continues to hold onto this notion of being driven by data, then I don’t really
see a good chance of rate hike before June 2016. I’d say so because the
seasonality continues to affect the data during the winters and markets,
believing that Central Bank would be driven by the data flow, would push the
rate hike expectations further despite Central Bank seeing it as a appropriate time
for policy normalization.
So in the end, I believe that it’s
about time that Fed
1. Determines
the appropriateness of remaining data dependent
And, if she feels so, to exercise more judgment
about the outlook so that the uncertainty is reduced and markets have a clear
view of when a rate hike would be more probable.Note: Errors and Omissions are expected because I didn't get it proof read by someone.