The Distrust of the Fed Has Reached a Dangerous Point

The new dot plots, showing where FOMC members expect interest rates to be in the future, recently came out. If you were to look at this predictive path in isolation, you would make the rational assumption that interest rates are going to rise by 2% or more in the next two years.

The chart below shows the FOMC’s expected rate should have increased four months ago. In June, by a margin of two to one, they expected at least two rate increases (if not more)this year.

Has the economy changed much since then? Not really, but somehow—afraid of their own shadow—FOMC members are now projecting (by a three-to-one margin) that there will be only one rate increase this year… of 25 basis points or less.

Here’s the plot from the September meeting:

The Schizophrenic Fed

This constant rethink is not just a recent phenomenon. We’ve seen it ever since the FOMC began to give us their forecasts for interest rate hikes.

Less than two years ago, they were expecting today’s rates to be around 3%… and to reach 4% by the end of 2018! Each subsequent quarterly plot is revised downward, but the pattern remains the same.

Rates are going to “normalize” in a time frame that is always just around the corner but never seems to arrive. The chart below, from Business Insider, shows the paths of their rate predictions. The dotted line down at the bottom shows what has actually happened.

This reveals an interesting dichotomy. The Fed determines what interest rates will be. So what they’re doing is predicting what their own decisions will be.

Federal Reserve economists have basically gone “0-fer” with all their predictions for the growth of the economy. This is a predictive task that is orders of magnitude more difficult than predicting what they will decide on interest rates. But, they have also gone 0 for 11 quarters with their predictions for their own monetary policy!

Between the time they make their forecasts and the time they actually have to make a decision, something always happens to keep them from pulling the trigger. I think that something is Yellen and her inside crowd of ultra-doves in the leadership of the Fed.

The biggest danger of all

This brings us to my main point: People are losing faith in the Federal Reserve. And not without reason. Ben Hunt says the Fed is “losing the narrative.” By that, he means that most Americans are skeptical of the Fed’s happy talk and no longer think that Fed policies will result in the economic growth projected.

We will have another financial crisis and/or recession, probably soon, and we can’t trust the Fed to respond correctly.

We’ll be lucky if whatever comes out of their Frankenstein lab is only ineffective. There’s a very real risk they will make the situation far worse. The masses of unprotected people are in no mood to swallow more monetary policy medicine.

In an ideal world, we might be glad to see the Fed stand aside and let markets adjust themselves. The problem is that any adjustment will now be extremely painful for a large part of the population.

So the Fed may be damned if it does and damned if it doesn’t.