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KBRA: 3 reasons the Fed won't change interest-rate policy

"Adverse market conditions in the future"

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The Federal Open Market Committee is nearing the end of quantitative easing, spurring a lot of questions in the market on what the future holds.

During the Federal Reserve Bank of Kansas City’s Jackson Hole Conference last month, Federal Reserve Chair Janet Yellen said little to predict the future of the market, stating the labor market might or might not be changing.

And as a result, Kroll Bond Rating Agency’s Christopher Whalen suggested in a report that the Fed’s ability to impact the performance of the U.S. economy is limited.  

Although there is talk about normalizing interest rate policy, KBRA argues that investors and the financial markets may be overestimating the willingness of the FOMC to make a change in interest-rate policy for three key reasons:

1. The majority of the committee is tied to a neo-Keynesian worldview, believing that interest-rate policy can positively impact the economy and employment. However, according to KBRA, all the evidence points in the opposite direction.  

“The fact, for example, that mortgage lending volumes continue to fall and home price appreciation is visibly decelerating — even as interest rates decline — suggests that traditional monetary policy is no longer working as before with respect to the real economy,” Whalen stated.

2. It’s unclear if the Fed actually has policy tools in place to increase interest rates. “Simply stated, there are few obvious levers for the FOMC to use to increase market interest rates because the Fed continues to support short-term markets,” the report said. Instead, the FOMC should limit the remaining special liquidity facilities put in place during the financial crisis and begin to actively push private counterparties to resume normal money market activities.

3. Is a normalization of interest rates in the near-term even possible? Due to the dovish composition of the FOMC, the agency sees no indication that the FOMC is likely to support any change in policy for the next 6-12 months.  

“When Yellen and her colleagues on the FOMC worry about slack labor markets but ignore clear signs of inflation in financial assets, we worry that the Fed may be creating the circumstances for another period of financial market instability,” Whalen said.

Because of the Fed’s refusal to normalize interest rates now, during a time of high investor demand for assets, and relative economic stability and growth, Whalen believes that it could lead to adverse market conditions in the future.

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