It's Fed Day! The "Will They Won't They?" Will Finally Be Answered

Today, Thursday September 17, 2015, is the final day of the Fed's two day meeting. This has been one of the most anticipated meetings in some time, and for good reason. Although any rate increase will be modest, the shift in policy direction and market perception will be massive, indicating the beginning of the end of easy money policies, and the start of a tightening cycle.

NO FED RATE HIKE

"Won't they!" The Fed decided to hold off on raising the Fed Funds rate at today's meeting. The move would have been more symbolic than material. Any move would have been limited and would only been a statement move that "liftoff" has begun. Today's non-action puts that off for at least another meeting, which is in October.

Was This the Right Decision

"What is the Fed afraid of?" If the U.S. economy is as strong as Yellen repeated it was over and over in her post meeting press conference, what is the Fed obsessing over? According to Yellen's comments, China's economy and market volatility influenced the Fed's decision not to raise rates at this meeting. So has the Fed introduced an additional factor in their decision making process? On the surface it appears that is what they have done. If the Fed has introduced an additional consideration, it complicates the proper equation to make policy decisions going forward. If different metrics can be introduced regarding policy decisions, it makes anticipating Fed moves nearly impossible and hinders the Fed's desire to be more transparent in its decision making process. Unfortunately, the Fed has introduced more uncertainty in to an uncertain environment and market volatility is likely to continue. Now investors get to continue to game the Fed.

If the Market is Always Right, Why are Central Banks Meddling?

One of the first investment lessons about asset markets is that price is king, price is always right. The market will dictate what the price is for an asset. This is a basic tenet of investing in asset markets. The price may be different next year, next week or tomorrow, but today the price is right. This is something all investors agree upon. However, if this is widely held as gospel within the investing community, why are central banks around the developed world waging an unprecedented assault on global asset markets, force-feeding asset prices on markets?

ZIRP and QE

Zero-interest rate policies (ZIRP) and quantitative easing have dominated global central banks for the better part of the last seven years. The US Fed established its Fed funds rate at near zero back in December 2008 and hasn't budged since. In addition to this policy the Fed also implemented quantitative easing, or QE, its asset purchase program to keep longer term rates lower and to inject liquidity in to the marketplace. Both of these policies have been mimicked over the years by various central banks around the globe, some to a lesser extent and others to a greater extent. The latest effort taking place in Europe on  Thursday, September 3rd, where Mario Draghi, the European Central Bank's president, threatened to provide additional stimulus in the wake of the weakening Chinese economy and its potential threat to the Euro Zone's middling economy. The purpose of these policy actions is to manipulate markets. The price of assets are directly affected when the Fed makes a move. But this is normal and happens all the time, right? It is normal and the Fed and Treasury make policy decisions often in hopes to affect markets. That is why they have the ability to make policy changes. If they didn't affect markets, why bother? Although this is all true, it's the extremity and duration of the policies that are twisting markets and not allowing them to function properly.

Dislocations and Misallocations

One of the effects of all the Fed intervention is creating market dislocations. Under normal circumstances, assets price themselves as a function of other assets in the market place. For example, corporate bonds typically price at some function to US treasuries, some spread. Corporate bond prices reflect their inherent risk vs US treasuries through a spread in yield. This spread reflects the premium necessary to adequately compensate investors for the additional risk. During this latest era of easy money, these spreads have been compressed and have not represented the additional risk investors have been taking. This is a problem because it disguises the actual risk that is being taken by the investor, the creditor, and the executive boards of companies that are accessing the capital markets, and creating imbalances.

An additional symptom of the extended current policies is a misallocation of capital resources. Corporations are buying back their own stock and issuing dividends at historic rates. They are doing this financial engineering to prop up stock values and mask the absence of true business expansion through capital expenditures. Companies are not growing so the economy and GDP growth is reflecting this reality, while stock values keep rising. Another misallocation this creates is fund flows from safer investments to riskier investments, often outside of a normal investors risk profile, or better said, the "search for yield." An example of this phenomenon are retirees buying more stocks and less bonds suitable for their normal risk profile, in order to increase revenue.