The Federal Reserve holds its once-per-six-week meeting this Tuesday and Wednesday, March 19 – 20. The Fed’s decision on interest rate and monetary policy is due in an official announcement Wednesday at 2pm EST.

The upcoming decision is viewed by market participants as being more important than usual. Due to the recent change in language witnessed by the Fed during its last meeting, January 30. For reference, the January 30 meeting was the first central bank decision since the nearly 20% US stock market decline witnessed from late September through late December 2018, which has now been mostly recovered.

Fed Language Change

At the January meeting, the Fed decidedly altered the language that it had been using since the first interest rate hike of the present cycle in December 2015. Specifically, while for the past three years the Fed had unequivocally indicated that it intended to continue raising short-term interest rates, at the January 30 meeting the central bank suddenly changed its tone and hinted that it might not continue its hiking campaign.

Consider the language from the September 26 meeting, just three trading days after the all-time high in the S&P 500 stock index at 2940:

“The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced [emphasis added].”

Compare this to the tone just two Fed meetings later, on January 30. The actual language that the Fed used was cloaked in “bank-speak”; but note the emphasis points, which we will analyze below:   

In light of global economic and financial developments and muted inflation pressures, the Committee will be patient as it determines what future adjustments to the target range for the federal funds rate may be appropriate to support these outcomes [emphasis added].

So: within just four months, the Fed changed its model from one of the further rate increases to one of indecision. Hmm…

On Fed Policy

Why is this potential change in policy so significant?

What we see here is that the Fed is directly responding to stock market weakness in its policy announcements. What other “global economic and financial developments” could the bank be referring to, other than the 20% stock market correction that had just ended a month prior? There had been no other significant developments in US or global markets over the previous six weeks. Which could fit such language.

Directly responding to stock market weakness is not within the Federal Reserve’s mandate as given to it by Congress in 1933. The Fed’s mandate is two-fold:

  1. Foster maximum employment.
  2. Support stable prices.

Nowhere in the Federal Reserve Act does Congress authorize the Fed to respond to 20% corrections in asset prices by hinting at policy changes.

However, this is exactly what occurred on January 30.

We are embarking on unknown territory here in central bank behavior. Should the Federal Reserve continue to respond to weakening stock market prices and in fact cease its current interest rate hike campaign, this would be the lowest new-normal for rates since World War II, at under 2.5%:

Low Rates Cause Inflation

Let us recall that the Fed does not have a “magic lever” by which to automatically keep interest rates at 70-year lows. In order to suppress interest rates – the market’s natural cost of borrowing – the Fed must continuously buy the short-term side of the bond market. By buying bonds, it forces upward the price of those bonds. Which in turn suppresses the associated bond coupon payment in percentage terms, i.e. the interest rate.

The key question to always ask whenever any central bank issues policy changes that may require purchasing an asset. From where do they get the money?

The answer: with freshly-created electronic fiat currency.

In other words, if the 2.5% interest rate is going to be the new normal in monetary policy. It will require the Fed to continuously print/create new money for as long as it maintains the abnormally low rate. This is the definition of inflation.

We will know a lot more starting this Wednesday afternoon at 2 pm.


CHRISTOPHER AARON
BULLION EXCHANGES MARKET ANALYST

Christopher Aaron has been trading in the commodity and financial markets since the early 2000s. He began his career as an intelligence analyst for the Central Intelligence Agency. 

Christopher Aaron specializes in the creation and interpretation of pattern-of-life mapping in Afghanistan and Iraq. His strategy has helped his clients to identify both long-term market cycles and short-term opportunities for profit.

This article is a third-party analysis and does not necessarily match the views of Bullion Exchanges. Do not consider Bullion Exchanges as financial advice in any way.

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