The Fed Is Trapped Knows It

What should the Fed do, or more to the point what can they do? They have turned on the taps since 2008, and turned them up even further in the last year whilst reducing interest rates. In my view they have had no other choice but to do this. A country and economy the size and powerhouse of the US cannot ignore the damage that this pandemic has caused to small businesses and the unemployed. The figures involved with this are huge. $120bn printed every month with roughly one third of this being mortgage backed securities, such is the worry we are heading for a repeat of 2008 collapse.

The debt levels are out of this world crazy. The current US debt clock is $28.4 trillion. Fast forward to 2025 and that figure is currently forecast at $50.3 trillion. Scary, scary numbers.

The Fed’s narrative has been to let inflation run hotter than the target 2% and only to “think about thinking about” raising rates when unemployment levels reach pre-covid levels – which we aren’t even close to based upon last month’s nonfarm payrolls and continued unemployment claims. What we need to understand however, is what raising rates will do, and how tapering will affect the economy. The well known “taper tantrum” that affected the markets in the run up to year end a few years ago is a mistake the Fed has learned from and said they won’t make again. They promise to provide plenty of warning next time they plan to do this. Changing interest rates on the other hand is a completely different ball game.

Consider the debt and the current interest rate. A change from 0.1% to 0.2% doubles interest rate payments. The average consumer is so used to “cheap money” that markets are at the most leveraged for years. This is putting to one side that the US cannot afford the repayments at current levels let alone having them at a higher rate. Stock markets, currently well over extended and at record highs will tank if rates go up. Insolvency will hit a lot of the smaller firms who will not be able to afford repayments and the country will be headed towards another recession. Do they want to take that gamble?

The debt crisis is the biggest problem facing the Fed. They are trapped and they know it. Even nominally raising rates has the potential to lead to a crisis across the country. Transitory inflation is a double edged sword. On the one hand it helps the country believe we aren’t heading into a major crisis, but on the other hand it won’t help pay the huge swathes of debt off that are currently accruing near $3 million every minute. There needs to be a plan on how this debt is paid off. I believe that has been happening for years and is soon to be announced, which is why I don’t see the Fed raising rates.