Looks like the Fed could have a problem on its hands. Not surprisingly, considering it’s been playing the short game for years. But eventually the long term gets here.
The choice may come down to whether to save the bond market or the dollar. While it may seem odd to worry about the bond market when the ten year yield is only in the 1.5% zone, this is a multiple of that only months ago, and we know Congress plans truly epic supply over the coming months. The Fed will either have to let bond prices continue to fall or escalate already massive purchases even further. The former would also mean crashing the stock and housing markets. The latter would mean crashing the dollar itself.
But this is the corner into which the Fed has painted itself. For Greenspan’s repeated missions to support stock prices, for Bernanke’s introduction of a 2% “inflation” target, for Yellen’s waiting-for-Godot failure to normalize rates when the getting was good, for Powell’s caving in his attempt to normalize on a mere 20% pullback in stock prices, the Fed bought the dilemma it faces now. On the installment plan. But the price wil be paid by ordinary people.
The banking system creates money by lending. To create more money, the Fed cuts rates, prompting more borrowing. The ratcheting down of rates over a period of decades has resulted in an epic mountain of debt. The debt represents demand for money, a deflationary force, which the Fed then addresses by more rate cutting. A patently unsustainable model. No Monday morning quarterbacking involved. As the record on this site attests, we’ve seen it coming for years.
Can the Fed muddle through? Anything’s possible. My guess is it will try to have its cake and eat it, threading the needle by trying to partition the pain between both the bond market and the dollar, like the kid who spreads the peas around his plate to make it look like there’s less. That could build a bridge to a longer term solution if the Fed sends a clear signal that it’s willing to change course, to abandon its view that lower rates are the solution to every problem, that if something didn’t work, it only needs be done more forcefully. More of the same kind of thinking that led to this point, however, will not.