Blog : Fed Hawks Are Clueless

by Ed Zwirn on September 5th, 2014

Two surprise developments this week should have taken the wind out from under the wings of Fed hawks. To be sure, you are likely to hear loads of speculation ahead of the U.S. Federal Reserve Bank monetary policy statement due out Sept. 17 that some Fed governors are all for tightening the reins on the economy and compounding the backout from quantitative easing with a rise in interest rates soon afterward.

But don't pay attention to any of this. Any further round of Fed speculation should be treated as a buying opportunity, assuming it creates market-wide dips. The Fed won't (and more importantly, can't) raise rates any time soon, and to think that it might do so ignores just how irrelevant (and powerless) the U.S. central bank is becoming.

Surprise number 1: Okay, so the latest jobs numbers may not be indicative of a major dip in the domestic economy, but they hardly constitute the evidence that the Fed would need to justify tightening. The Bureau of Labor Statistics Friday release showing a measly 142,000 jobs created in August, the smallest monthly gain this year, came as a surprise to a market which had been expecting the number to weigh in at 225,000.

Granted, there are reasons to think that this poor showing may be a fluke, and be subject to upward revision next time around. For one thing, August is more typically revised than other months thanks in part to quirks like teachers returning to work and retailers gearing up for the back to school and holiday seasons. For another, the economy is performing nicely, with Gross Domestic Product having grown 4.2% in Q2 according to the latest revised estimate.

In addition, the ADP Employment Change report, which comes out the day before the "official" BLS numbers and is therefore widely used to bet on them, showed a much larger gain, 204,000, bolstering the guess of those who expect the revised BLS number to eventually come in higher.

But, however you sugarcoat it, the jobs numbers constitute a disappointment, making it hard to imagine that Federal Reserve Chair Janet Yellen, who is the Fed's leading dove in any case, will come out at her FOMC press conference and call for higher interest rates.

Surprise number 2: If the jobs report constrains the Fed from undertaking any tightening of monetary policy, or even discussing it much this time around, the latest policy announcement by the Fed's European counterpart, the European Central Bank, underscores just how constrained the Fed is at this point.

The ECB already upped the ante for the Fed in June when it effectively devalued the euro by introducing negative interest rates, attempting to boost cash in circulation by actually charging banks for the privilege of parking funds with it for short periods. But the ECB's latest pronouncement on Wednesday took even hardened ECB watchers by surprise: The bank lowered its main lending rate from 0.15% to a new low of 0.05%. It also drove its overnight deposit rate deeper into negative territory, now charging banks 0.2% to leave funds with it.

At the same time, the ECB made another move that puts it squarely at loggerheads with the Fed. Even as the Fed continues to taper off asset purchases under its so-called Quantitative Easing program, the ECB announced it would start buying asset-backed securities each month in an attempt to unblock lending in the euro zone.

In making both these most recent moves and the June announcement, the European central bank has pointed to its concerns that economic performance is languishing on the continent and that inflation is too low and could eventually produce a deflationary spiral similar to the one that has crippled the Japanese economy for decades. The ECB on Wednesday also cut its growth forecasts for the 18-member euro zone, predicting GDP growth of 0.9% this year and 1.6% in 2015.

Americans can feel justly grateful that their country's recent economic performance economic performance has been nowhere near as dismal as all that. But, for better or worse, the U.S. economy is more tied than ever to the global economy, and this tie-in limits the leeway for U.S. monetary policy. Put another way, the Fed would have to be confronted with unmistakable evidence of an overheated economy to raise interest rates and risk making U.S. products more expensive overseas by boosting the value of the dollar.

It is not for nothing that both the Fed and the ECB (not to mention the Japanese) have each targeted an inflation rate of 2% as optimal. In both the U.S. and Europe, inflation has hovered well below this seemingly distant target. If a worldwide deflationary trend takes root, which is a not-too-unimaginable possibility, it will be even harder to shake than it is now. The only winners involved will be people (and companies) who have succeeded in hoarding large amounts of cash. The rest of us, on the other hand, will be busy sucking up to them.