What is the Fed’s role?
F15s and F16s over Kuwait, 1991. Photo: USAF. Source Wikipedia
Yesterday the Fed decided to keep interest rates near zero. It was a tough call. Employment has improved by more than the Fed expected, but inflation has moved away from the Fed’s target. Economists were evenly divided as to whether they would or even should raise rates this meeting.
In their statement, they comment that “recent global economic and financial issues may restrain economic activity.” Janet Yellen reinforced this in her press conference, where she said that they focused particularly on China and emerging markets. In other words, global markets spooked the Fed. They really are in a box: volatility rose and stocks fell because the Fed was expected to raise rates. With policy unchanged, volatility will fall and markets rise. And the next time the FOMC is ready to raise rates, markets will sell off again, spooking the central bank—lather, rinse, repeat.
VIX Volatility Index. Source: Bloomberg
It’s particularly notable that the FOMC chose to focus on global issues. The Fed is really acting as if they are central banker to the world. The market recent correction began in China, where concerns about their slowdown have led to a 40% pullback. China accounts for an increasing share of the world’s economy. But they have their own currency and their own central bank.
It’s hard for the Fed to be the world’s central banker. No one elected them; The UN didn’t appoint them; domestic citizens won’t understand; foreign folks will resent what seems like US hegemony. It’s a thankless task—like when King Arthur rides up to a peasant in Monty Python and the Holy Grail: she says, “You’re King? I didn’t vote for you.” But nature abhors a vacuum. Having stepped into the role, the Fed will find it hard to walk away.
It’s like being the world’s policeman—all you have is force, and there’s nothing to legitimize your power. But once you’ve begun, the alternative is chaos.
Douglas R. Tengdin, CFA
Chief Investment Officer