Does the Fed have a Looming Credibility Issue?

A View from the Beach
A View from the Beach

February 2, 2016 — We are anticipating the coming employment report this Friday because mortgage markets tend to move around important economic announcements and this, potentially, could be one.

Here is the view of an investment service – RateLink – that I follow:

The Federal Reserve hiked rates in December for the first time in almost a decade.  Global markets expected it.  Chairperson Yellen and other Fed officials spent an entire year telegraphing the move.  At first it was going to be August, then September for sure.  They delayed the hike because of weak economic data and global financial unrest.  Each time they punted we were assured that it would happen at the next meeting.  Eventually we got a small increase of just 1/4%.  This was really nothing looking at it from a singular point of what the increased borrowing costs would be for banks that use the Fed’s lending facility.  But it was much more than that.

The Federal Reserve has two mandates from Congress, full employment and price stability.  With the unemployment rate at 5% and the creation of 292,000 jobs in December the Fed believed that the mandate was met.  While price stability (read inflation) has been stubbornly low for years, we have been assured that “rising prices were just around the corner, just wait and see.”  Following the December meeting  Yellen signaled there could be three or more hikes in 2016.  She toned that rhetoric down last week but did not indicate that rates hikes were on hold.

In the 28 trading days following the hike the Dow lost 1700 points which wiped out trillions of dollars of global wealth, oil prices fell to levels not seen in 12 years, the European Central Bank (ECB) promised more QE, and on Friday the Bank of Japan (BOJ) took markets by total surprise with a deposit rate cut into negative territory.

Back to the question, does the Fed have a looming creditability issue?  A growing number of economists believe the December rate hike occurred because the Fed had painted themselves into a corner.  If one were to only look at the US economy, an argument could be made for the rate hike.  But the world is more interconnected than ever and the decisions that a central bank makes are not made in a vacuum.

Expect more volatility in the week and months ahead.  Prepare your referral sources and borrowers for the possibility of daily price swings.

Not all volatility brings higher rates, however volatility can be disruptive in your daily work if you are unprepared for it.  Remember that the #1 reason rates move is the release of economic data.  Be especially vigilant ahead of the significant data such as the monthly Bureau of Labor Statistics employment situation report released the first Friday of the month.

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