Hey guys, welcome this fundamental review video for May 2016.
So last week there was a big surprise in the markets when the FOMC meeting minutes revealed that the US Federal Reserve was seriously considering a rate hike in June .
This was a surprise because practically no one had expected a rate hike to come so soon this year.
And to understand why, we need to go back to when the Fed first began with forward guidance.
So what’s forward guidance?
It’s basically the Fed saying that they’ll give everyone hints on the future path of interest rates. And this implicitly means that they expect everyone to take them at their word.
But here’s the problem. Since 2008, the Fed has tried 15 different policies.
If you remember, they first cut interest rates to zero in the period 2007 – 2008. We also saw 3 rounds of QE followed by Operation Twist. And unemployment and inflation targets that were first changed, and then later completely abandoned.
Then in 2014, the Fed announced that they expected rate hikes to come in 2015. But it was only in December when the Fed finally hike rates by 0.25%. So that was just one hike in 2015 which was a big difference from what they had implied in 2014.
Then they claimed to expect 4 rate hikes in 2016. So people expected the hike to come in March, that didn’t happen, and now we are in May… still no rate hike, but now the Fed has come out to say that we might have a rate hike coming in June.
So a lot of people are skeptical of what the Fed is saying… because this is what usually happens: the Fed first hints at a coming rate hike, the markets react (USD goes up, stock markets go down) and when the time for the rate hike comes, the Fed delays, does not hike, and this announcement usually comes with a dovish message, and then the market reverses (USD weakens stock markets go up again) as people expect the Fed to remain dovish… and then the Fed will suddenly claim to want to hike rates again.
So this is the cycle that we’ve been seeing in the past few years. So a lot of people are now understandably skeptical of the Fed’s ability to hike rates in June.
So the question to ask is: Is the Federal Reserve stupid? Because their economic projections have been pretty much wrong, every single time.
Here are 2 things that we know for sure. First, forward guidance does not tell you what is likely to happen next. In fact, you’d probably be better off anticipating the opposite of what the Fed says they think will happen.
And secondly, we know that the US dollar has stopped moving aggressively because of the Fed’s forward guidance alternating between hawkish and dovish.
Now because of this, people are starting to doubt the Fed’s credibility and their forward guidance.
But if you look at the big picture, there’s another explanation to all this, that is in my opinion, makes more sense… because I don’t think the Fed is stupid.
So what I think the Fed is doing. I think that they are using the threat of rate hikes to buy time for the US economy to recover, without having the US dollar strengthen too quickly.
This is important because a strong US dollar makes it very difficult for the US economy to recover.
But the Fed can only pull this off, if they keep the markets confused about what they’re trying to do. The only way the Fed can keep manipulating market expectations, is if people don’t know that that’s what they’re trying to do.
So with this in mind… is there going to be a rate hike in June?
Given the Fed’s weak forward guidance record, most people would not expect a hike in June.
But that’s exactly why I think there’s a higher chance of a rate hike in June than most people expect.
Because, if you believe that the Fed wants to keep the markets confused, then a June hike would do a pretty good job at accomplishing that.
This being said, I will not be betting on a June hike, and I’d suggest that you don’t either.
The purpose of this video is to highlight why I think the Fed might actually hike in June, so that you don’t bet heavily against it.