There is an old saying in financial markets; “don’t fight the Fed”. It is short and to the point and it survived for long enough for there to be a lot of merit in its wisdom. However, as each new generation of investment managers and traders arrive, there is an understandable tendency for them to not to be fully aware of the foundations of such sayings or indeed ignore them. Almost as famous is the expression “this time it is different”.
The original saying simply expressed the view the US Federal Reserve is powerful and has more ammunition than any one market player. If the Fed wants to move rates a particular way to move the economic dial then inevitably that change will occur.
YieldReport came across an article this week which make one wonder if it is not timely to remind readers of this saying. In response to investment managers’ expectations of very slow interest rate rises out of the Fed, Deutsche Bank’s head of fixed-income trading was reported as saying, “It is not that the market is fighting the Fed. It is the market thinks that it has the more accurate forecast than the Fed and that the market thinks that the Fed may not raise rates for the remainder of the year.”
YieldReport is not suggesting this view is held by the manager referred to above and is anything other than an interpretation of what other participants are thinking. However, if the market collectively believes its forecast of the path of US official rate rises is more accurate than those put forward by the Fed themselves then it is being courageous in the “Yes, Prime Minister” sense. Markets are far from infallible and that is why there are booms, busts and “corrections”. One of the major tools in the central banks arsenal is the ability to jawbone markets; that is, move markets through speech rather than direct action. It is generally more cost effective for the central bank to work this way lest the market work out that central banks do, in fact, have limits as to what they can spend to achieve their monetary policy aims.
This central bank invincibility has taken a battering in recent years with analysts openly questioning whether central banks have lost control of the quantitative easing experiment. After all, trillions of dollars have been spent trying to generate economic growth and the results are less than flattering. Analysts are forever trying to interpret what the Fed is thinking in terms of moving interest rates and the latest view as expressed above perhaps reflects the once-effective central bank tool of jawboning a market is having much less effect. Nonetheless it is generally either brave or foolish to “fight the Fed”’ by betting against it.