THE FED IS NOW PART OF THE PROBLEM / SEEKING ALPHA

The Fed Is Now Part Of The Problem

By Parke Shall


Summary


•The FOMC said yesterday that it is not raising interest rates.

•The equity markets tried to rally, until reality set in, pushing equities lower.

•The Fed is now officially part of the problem.


In trying to do its job, the Federal Reserve has just made things infinitely worse, we believe. By now, many of you know that the FOMC's decision yesterday was to leave interest rates unchanged, due to what the Fed saw as an imperfect global economic picture.

From The Washington Free Beacon:

The Federal Reserve has decided to keep the federal funds rate near zero despite broad speculation it would increase rates at its September meeting, according to the latest Federal Open Market Committee (FOMC) statement.

The Committee said it will keep the federal funds rate near zero until the economy has seen further improvement toward reaching the Fed's goals of maximum employment and inflation approaching 2 percent.

The Fed has not given a clear signal as to when it will raise rates.

"Even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run," the FOMC said.

The market's reaction yesterday should tell you all that you need to know about this situation. When the news was announced, the market tried to rally, but was unable to do so. In the 2-3 days prior, the market had gradually made its way up, as the general consensus was that a rate hike was more than likely to happen.

We think that heading into the minutes yesterday, the market was all but certain that a rate hike was going to occur, and the decision by the Federal Reserve came as a surprise, catching the markets off guard.

It was widely regarded that a nominal raise in interest rates after seven years would be the first indication to us with some certainty that the US economy has recovered significantly after the 2008 housing crisis. Everybody (except, apparently, the Fed) already knows that the economy has recovered significantly, and that we are in a significantly stronger economic climate then we were in 2007 and 2008. All a rate hike would have done was to acknowledge that the Federal Reserve is willing to make it official.

So, with the markets expecting a raise in rates and potentially getting ready to embrace the fact that our economy is now seen as stronger, the FOMC's move yesterday was catastrophic and is going to lead to further volatility.

Because the markets believe that the US economy is getting better, the Fed's comments have now left the markets in a place where we believe they are going to be significantly more volatile than they would have been, had the Fed simply raised rates.

As we move forward, should we hit more economic turmoil in the US, all the Federal Reserve is doing is eliminating one of its tools to make sure that it has the ability to keep a cushion around the US equity markets. With rates at zero, if a real economic disaster occurs, the Federal Reserve is not going to have many options. It could be ugly.

Not unlike China, the Federal Reserve is now being looked at in the US in a dangerous light. It's being viewed as a constituency that yields to the institutions and the very real long bias that says our markets need to be in a perpetual state of rising.

What does this mean for investors?

We believed, at first, that a rate hike would lead to a flight in quality in equities, where companies with high valuations would start to see some cash exit and head towards staple stocks, value stocks, and other reasonably priced reliable equities. In this case, we now have a Fed that we believe is encouraging investors to continue throwing money into the market without rhyme or reason, and we believe that this is going to make things far more difficult when the time comes to either raise rates or deal with more economic slowdown globally.

The longer the Fed puts this off, the worse it's making it.

We are dealing with this by taking some profits in some companies and leaving on some of our long term-focused staple stocks. We are also looking at hedging strategies for what we believe will be more volatility, the likes of which we've seen over the last two months, heading forward.

We said that the Federal Reserve needed to get it right this month, and it did not.

It has to be difficult for those in the working class who are looking for yield on their savings.

Once again, the people that are doing what they're supposed to do - which is sock away money and save diligently - are getting the short end of the stick so that the Fed can appease the likes of large institutions who continue to want the equity markets to advance, despite many technical indicators and a global economic climate that are telling us that these markets need to take a breather.

Can we wait until December?

The markets will answer that question for us. For now, be advised that we believe the Federal Reserve has made the situation worse for US investors, and that we are heading into the end of the year with a new degree of caution that we would not have if the Fed had moved rates higher yesterday.