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Sunday, March 23, 2014

Yellen's Dots

The dots are moving higher.  Yikes!  Now more Federal Open Market Committe participants expect the Federal Funds target rate, which they control, to be at 1% at the end of 2015.  This is a move up from December's expectations and up from the current target at 0 -0.25%.  This reflects their view that the economy will be better and inflationary pressures beginning to head towards 2%.

IMHO, it is a sad state of affairs that Fed-watching has gotten to this point; but it is an inevitable outcome of a policy that tightly controls the most important price in the economy - the price of money. Deciding to reduce or increase this price via short-term interest rates favors or penalizes primarily real estate and autos, in the process thereby shifting or taking resources away from other sectors of the economy. 

Thinking through the consequences of tightly controlling interest rates answers some of the questions asked at Yellen's press conference, one of which questioned why the labor market improvement has been anemic despite aggressive policy stimulation.  Simply, in 2003 the Greenspan Fed pushed rates down to 1% and the worker force shifted to real estate - becoming brokers, mortgage lenders, construction workers, etc.  Then with a 2x4, it hit the labor market square on and pushed rates higher--throwing those sectors out of work.

To make a long story short, the labor market is not a simple commodity market.  Workers get experience in a certain area; they do not just change on a dime as prices are manipulated and their sector goes in and out of favor.  At every Fed Chairperson press conference, the question will be asked on why the recovery is taking so long.

Wall Street's perspective is simple:  the Fed is printing money and that money is going into stocks. Starting to close the spigot means stocks will have to trade or be priced the old-fashioned way--on earnings.  And that is scary, especially at present lofty levels.

The best policy move the Federal Reserve could take is to abandon controlling interest rates and to let the market set the price of money.  After all, that's what a free market is supposed to do.  Then Yellen's dots (based on FOMC member forecasts of economic activity which are themselves typically way off base) would be an academic exercise--which is what they should be. 

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