How is the Federal Reserve like the Swiss National Bank?
On January 15, 2014, the Swiss National Bank (SNB) cancelled the peg which bound its franc to the euro. The result was an immediate and massive revaluation of the franc which caused enormous dislocation around the world. Fortunes were lost, foreign exchange traders went out of business and the credibility of central banks took a very direct hit. Just days before, a top SNB executive had assured a national television audience that no changes were being planned for the peg. Central bank omnipotence is now more open to question.
How is the Federal Reserve like the Swiss National Bank?
On January 15, 2014, the Swiss National Bank (SNB) cancelled the peg which bound its franc to the euro. The result was an immediate and massive revaluation of the franc which caused enormous dislocation around the world. Fortunes were lost, foreign exchange traders went out of business and the credibility of central banks took a very direct hit. Just days before, a top SNB executive had assured a national television audience that no changes were being planned for the peg. Central bank omnipotence is now more open to question.
We believe that the Federal Reserve may also be on its way to breaking a promise of even greater magnitude. The Fed has assured investors that it intends to raise short term interest rates this year and has allowed markets to conclude that the first hike will take place around mid-year. This perception has strengthened the dollar and sustained what we believe is a wholly unwarranted confidence in the health of the US economy. How do we know that the US economic recovery is real? Because they are going to raise rates. We sincerely doubt it.
We are told that the Fed has set a 2% inflation target. We are told this is an important target to achieve because inflation and sustainable growth are mutually dependent in its economic models. We are told that the Fed's Zero Interest Rate Policy (ZIRP) has been implemented to achieve this inflation rate and associated higher economic growth which is just around the corner (and has been for five years of unmet projections). We observe that the Fed's preferred inflation measure, the PCE, is actually declining. Chairman Yellen recently declared that falling inflation is transitory but we note that the Fed has failed to meet its inflation target for 32 straight months. Nonetheless, the Fed tells us they intend to raise rates, which their own models say is deflationary. Is this not confused?
The Fed appears to be doing nothing more than attempting to manage expectations. In our view, the Fed has no idea when or how it will raise rates.
How are the Fed and the SNB alike? Perhaps they both make promises they cannot keep?