I am continually amazed at how many investors and analysts hang their investments and/or trade decisions on what the Fed does or doesn’t do, says or doesn’t say.
As if the Fed controls the markets! Or any central bank, or combination of central banks for that matter!
Simply put, central banks have no impact on an economy or on market trends. None at all. Period.
At best, all they do is …
A. React to the economy and markets. And/or sometimes …
B. Get lucky and make a policy change or a verbal statement that tends to coincide timing-wise with what an economy or a market(s) is already set to do.
Let me dissect each of the above for you, by way of examples.
Reacting to the economy and markets
|The Fed merely reacts to what’s already happening in the free markets.|
Do you think interest rates go up because the Fed raises its official rate? Or that they fall because the Fed lowers its official rate?
If you do, then it’s time for you to learn a very important lesson: The Fed, or any other central bank for that matter, merely reacts to what’s already happening in the free markets.
If people, investors, and businesses are borrowing money, and that demand exceeds the immediately available supply for money or credit, then interest rates — the cost of borrowing — go up. Whether or not a central bank likes it.
Conversely, if money and credit are contracting because demand is weakening, then interest rates fall — again, regardless of what a central bank may want to see or happen.
Just consider the stock market collapses of 2000-01, 2003, or 2007-09.
What happened? Interest rates collapsed because credit was contracting and new demand for credit was also slumping. The Fed had nothing to do with it at all. All it did was follow rates lower by notching down its official discount interest rate.
Or consider the last several years of record low interest rates. Do you think they are low and heading lower in many parts of the world because central banks say so?
No, rates are at historical record lows because there is virtually no demand for money and credit.
Or consider the late 1970s, when interest rates were soaring. Stocks and commodities were booming. Credit demand was off the charts. Investors were willing to pay any rate of interest to invest in anything that had a shot at matching or bettering high inflation rates.
So interest rates went up together with most assets and the Fed could do nothing more than raise its official rate in tandem.
Markets and interest rates only peaked, not because Fed Chairman Paul Volcker raised rates to 20 percent in June 1981, but simply because that particular inflation cycle was due to end anyway.
Anyone who thinks or tells you otherwise is merely a rookie in the markets, or if they have any experience at all, is simply ignorant of how markets work.
Or consider last week’s Fed meeting and press conference, which in my opinion is the epitome of Fed follies and an amazing show of how there are so many investors and analysts who get caught up in watching the Fed.
At last week’s meeting and press conference, Chairwoman Janet Yellen removed one single word from the Fed’s official press release — the word “patient” — giving the impression the Fed was more ready to raise rates.
But then, in other wording in the press release, the Fed noted it “would not be impatient” raising rates either — giving the opposite message, that it would take its time raising rates.
And what did the bond markets do? Rates actually declined. Traders who bet that rates would rise due to the removal of the word “patient” got their heads handed to them …
While traders who bet on declining rates — which is the free market trend still in force now — made a couple of bucks.
I could go on and on with one historical example after another from the beginning of time, but the fact is this: Central banks have zero control over interest rates.
Anyone who thinks otherwise, I repeat, is simply a rookie, or completely ignorant of how markets work.
Now, let’s consider my point B, where a central bank may get lucky …
And make a policy change or a verbal statement that tends to coincide timing-wise with what an economy or a market(s) is already set to do.
This doesn’t happen all that often, but it happens enough that it leads many investors and traders astray.
Consider what I just told you about Paul Volcker in 1981. Many credit him with killing inflation back then by dramatically raising rates.
Not true. That inflation cycle was due to die off in June 1981 anyway. Volcker was merely lucky. He was in the right place at the right time.
Or consider again, last week’s Fed meeting. As I have been telling you, the euro was overdue for a bounce, the dollar for a correction, and gold and silver for a short-term pop higher — and that’s exactly what happened last week.
Did the Fed cause it? No way. The Fed merely reacted to the markets. The dollar would have sold off, the euro would have bounced along with gold and silver no matter what the Fed said or did.
It’s crucial that you understand this. The majority of investors and traders make their decisions on erroneous information and central bank watching and guessing. Do that and you are destined to never become a successful investor or trader.
Instead, focus on what the free markets are doing, what the major, big picture trends are, and on the charts. They tell you everything you need to know. And the facts right now are …
1. Interest rates are not headed higher for some time.
2. Deflation still rules.
3. The dollar remains in a long-term uptrend, the euro in a massive long-term bear market.
4. Commodities, nearly all of them, remain in bear markets.
Best wishes, as always …