Why the FED didn’t raise interest rate in the USA

Dear PGM Capital Blog readers,

Investors around the world have been closely watching the USA Central bank’s (The FED) decision on short-term rates, which have been near zero since the financial crisis in a bid to stoke growth and borrowing. That stance has helped propel a six-year-long bull market in stocks and bonds.

After keeping the markets on edge in the days and weeks leading up to the Thursday, September 17, decision, the Fed has decided once again to leave interest rates unchanged.

As can be seen from below, charts of the US-Markets, stocks fell sharply on Thursday and triple digit on Friday as investors processed the lingering cloud of uncertainty after the Fed’s decision not to raise rates from their record low.

Are things so bad in the world that we can’t get off 0% a whopping seven years after the depths of the credit crisis?

Shouldn’t it concern investors that the Fed is still too worried to raise rates by even a measly quarter point?

How is that long-term bullish for the economic outlook, corporate earnings or stock prices for that matter?

In a press release announcing the decision of the Federal Open Market Committee, the body responsible for setting monetary policy, the central bank said that;

The economic activity in the United States is expanding at a moderate pace. But while household spending, business investment, the housing sector, and the labor market are all improving, net exports have been soft.

The Fed didn’t explain why U.S. exports seemed to be lower than expected, but it’s reasonable to assume that it has to do with the strength of the U.S. dollar. A stronger dollar increases the cost of American exports abroad.

Four years ago, it took nearly US$1.50 to buy a single Euro, while on Friday September 18, it takes only US$1.1308 for one Euro, as can be seen in below chart.

Although the Fed’s legal mandate, insofar as monetary policy is concerned, is to maximize employment while keeping a lid on inflation, the value of the dollar plays a central role in both. This is because net exports are one of four variables that determine a country’s gross domestic product, or GDP. And the expansion or contraction of a country’s GDP is the fundamental driver of both sides of the central bank’s so-called “dual mandate.”

The second issue cited by the Fed for its decision to keep interest rates steady has to do with the dual mandate specifically, as can be read the central bank’s press release

Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term

In March 2009, the FED act exactly in line of its role when it printed US$1 trillion to buy government-insured mortgage-backed bonds. Fed actions thawed the frozen market, which resuscitated the buy side and helped things return to normal, albeit at a lower level.

The monetary institution is supposed to use interest rates and the printing press to prod businesses into hiring more people. This part of Fed policy has failed, but you wouldn’t know it by looking at employment figures from the Bureau of Labor Statistics (BLS).

Rather than raise interest rates for the first time since June 2006, policymakers opted to sit tight. Not only that, but they also sounded a much more cautious tone on the global economy, the outlook for inflation and more.

Originally, the Fed was built as a lender of last resort. In times of panic when banks needed to sell good assets for cash to meet depositor demands, someone had to be there with the ability to make good.

Gold prices enjoyed an expected bounce on Thursday as the Federal Reserve decided to hold interest rates, to close the week at US$ 1,138.10 as can be seen from below 3-day chart.

Gold finished the week up around 2.7 percent, snapping a three-week losing streak.

The Fed move also sent bond prices soaring, which pushed yields lower. The yield on the 10-year Treasury note fell from 2.30% Wednesday to 2.13 on Friday, September 18, as can be seen from below 1-week chart.

The Fed’s decision to hold off on a rate hike, puts the market back in the will they or won’t they mode, as the Fed meets again in October and December.

Based on this, we believe that volatility will remain in the market until there is a clear sign on the FED next move on interest rate.

Until next week.

Yours sincerely,

Suriname Times foto

Eric Panneflek

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