The Path to Normalization

I thought the Federal Reserve would raise rates in the aftermath of the market crash of 2008. you can see here that they didn’t. The LIBOR rate is often dismissed as a self serving mechanism for bankers to set rates where they would prefer to see them. The LIBOR rate was the more accurate gauge of where the market thought rates should be. Now the Fed Funds Rate has been consistently lower than what the banks think they should be. That seems to be changing.

The players keep changing roles.  

All that hip role playing drove James Dean crazy.  The real question how much damage was done to the economy by going against the market? One thing you can surmise, is that in the event of another crisis everyone will change roles again. Is the Fed ready to push rates higher than what banks think they should be? Does a policy of rate hikes through financial repression (Reverse Repurchase Agreements) signal they are serious about pushing rates higher through 2019? In the next crisis will the Fed raise rates to properly price risk, and maintain stability?

Is the Fed’s problem it keeps getting too far ahead of the curve? Each time since 1999 that the Fed raised interest rates, the markets crashed.  So it might seem that by 2008 they had learned their lesson, never never raise rates again.

fedrates If Greenspan had only dropped rates sharply to zero in 1999 we might have had prosperity. The question is why do rates have to be zero,  to prevent the economy crashing?

historical fed rates

This is the larger chart, so you see that even though the rate hike in the 1994 Bond Massacre resulted in a stock market rally, that was because those rates were still far below their recent levels. Rates in the short term weren’t rising as fast as rates in the long term were dropping.  Looking at this you may surmise that rates are already too high to prevent the markets from folding up.

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