The Federal Reserve is signaling a potential rate increase within the next few months with Fed Chairwoman Janet Yellen pulling out all the metrics to convince the markets and the country that it’s getting time to increase the cost of money. I, Jason Galanis, am curious to see what effect this has on the market.
Yellen is pointing to improvement in the jobs market (US unemployment fell 1.4% over the last year, from 7.5 to 6.1%), which came “more quickly than expected,” but is also warning of asset bubbles in biotech and social media stocks. Yellen seems to be suffering from a case of analytic myopia: instead of focusing on stock prices, unemployment and inflation at home, she should be looking at the enormous dollar bubble in emerging markets.
The Fed is using stock prices to gauge whether to increase rates because traditional inflation indicators are giving nothing but “noise,” i.e., numbers the Fed doesn’t like to think about. The Fed is a business like any other. It’s job is to ensure high levels of employment and stable inflation rates.
When Yellen called the 1.8% CPI increase “noise,” she was doing what any good chairperson would have done: downplay the bad numbers and focus on something else, like favorable price-equity ratios. Indicators the CPI and even Yellen’s personal favorite, the NAIRU (“non-accelerating inflation rate of unemployment,” which strikes a balance between full employment and price stability), are no longer of any real use to determine Fed policy. Even if they weren’t subject to all kinds of fudging, they simply ignore a huge part of the monetary picture.
According to the International Monetary Fund, the Fed’s low rates have enabled about $500 billion in loans to emerging markets, and even a small rate increase could trigger disastrous capital flight from India, Indonesia, South Africa, Brazil and Turkey. Easy money is a potent drug, and over the last five years the Fed has gotten a good part of the developing world thoroughly addicted.