Overnight the Federal Reserve kept interest rates unchanged in one of the most anticipated and closely watched meetings in some time. While the fact a change in rates was a 50:50 proposition the tone of the Fed statement accompanying the rate decision certainly was a surprise. A big surprise and a dangerous one in my opinion.
The Fed stated “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”
Firstly, by introducing the word “global” the Fed is now considering worldwide events in determining domestic interest rates. This is dangerous because what does this actually constitute and how do we measure it? Fearfully does this mean the performance of the Shanghai Composite Index? Is it measured by other emerging market indices?
All of this poses major risks to financial markets as it adds confusion to what their mandate is. Originally the goal of the Federal Reserve was to reach full employment which during Ben Bernanke’s tenure was below 7%. When we reached that level, it changed to inflation moving higher beyond 2%. And now it seems it’s the stability of “global asset prices”.
It seems to me the Fed is too scared to raise rates. And are looking at any excuse to not increase rates. As I regular say, if you were in a coma and woke up now in late 2015 and were told where US GDP is, consumer confidence at record levels, auto sales at record levels, S&P 500 at record levels, booming US house prices, unemployment at 5.5% – now guess where interest rates are at? I don’t think anyone would guess 0%.
So what is the Fed afraid of? Well now it seems its China. China and its stockmarket have been grabbing headlines across the globe in 2014. Firstly for its major rally and most recently for its plunge. Unfortunately the whole world has mistaken what the Chinese stockmarket represents. Unlike the rest of the world where stockmarkets reflect profits, economic performance and sentiment – in China it’s just a casino. Nothing more. And after a hot streak, like all hot streaks do, it’s turned cold. Macau gamblers are now losing on the stock market.
Below is a chart of the Shanghai Composite Index over the past 10 years. The index had been in decline over 2009 to mid-2014 which didn’t bother global markets at all. Only when the Hong Kong Connect was established that allowed investors in both markets to cross invest in each other’s markets via local brokerage firms did the Shanghai index take off. The programme opened on Nov 14, 2014 – exactly when the Chinese market began its rally. Markets were opened to a wider group of investors and speculators. Brokerage firms saw thousands of accounts being opened everyday.
When I state that Macau gamblers turned to the stock market I am not joking. Macau gambling revenue has been in free fall since the average punter has been able to play the stock market. So it’s also no surprise that the index peaked when the Chinese Government began to place limitations on leverage and speculation.
Unfortunately headlines of the Chinese stock market plummeting have been 100% interpreted incorrectly by the Western world. It’s not a reflection of the Chinese economic performance or fears of a “hard landing” for the economy. It is merely a gamblers profit and loss statement.
Now that the Fed is fearful of global financial market developments, does that mean they won’t have confidence to raise rates until the Shanghai market rallies back up? Does this also include other emerging markets? This is dangerous territory as the Fed begins to include other factors in determining domestic policy and run the risk of including so many things in their decision making process there will never be a perfect time of raising rates and will miss their opportunity.
I 100% agreed with Fed and US Government intervention in stabilizing markets in the GFC. There was no other choice and not doing anything ran the risk of a more catastrophic outcome than that which we saw. However now with markets at record highs they can’t be fearful of just a small correction that was inevitable anyway. By not raising rates they are also supporting the market’s incorrect view of China’s stock market performance and what that really means for the Western world.
September 2015 will go down as a missed opportunity for the Fed to show confidence in the US economy and in fact, stabilize markets with some certainty and normality. All we are left with is more confusion.
