This post Here’s What the Fed Does Next appeared first on Daily Reckoning.
The Fed raised rates yesterday, as I predicted back in December. The market dismissed it at the time, and only just caught on within the past couple of weeks. So basically, the market caught up with my forecast.
I don’t say this to pat myself on the back.
The point is, I use a rigorous scientific method to analyze and predict markets. I don’t guess or take positions just to get attention. I constantly apply new data to test my original hypothesis. If the data confirms my hypothesis, I stick with it. If the data conflicts with it, I step back and re-evaluate. You have to stay nimble.
I’m a big critic of the Fed models, but that’s because they’re obsolete and they don’t record with reality. You need the right ones.
The reason why I was able to accurately predict yesterday’s rate hike back in December when Wall Street gave it little chance, is because Wall Street is looking through a backward looking lens.
It’s looking back at 40 or so business cycles since the end of World War II. In a typical business cycle, the economy starts from a low base, then gradually business starts expanding, hiring picks up, more people spend money, and businesses expand.
Eventually, industrial capacity is used up, labor markets tighten, resources are stretched. Prices rise, inflation picks up and the Fed comes along and says “Aha! There’s some inflation. We’d better snuff it.”
So it raises rates, usually for a full cycle.
Eventually it has to lower rates when the process goes into reverse. That’s the normal business cycle. It’s what everyone on Wall Street looks at. And historically, they’re right. That process has been happening 40 times since the end of World War II.
The problem is, that’s not what’s happening now. We’re in a new reality. This is a result of nine years of unconventional monetary policy — QE1, QE2, QE3, Operation Twist and ZIRP. This has never happened before. It was a giant science experiment by Ben Bernanke.
And that’s the key…
You have to have models that accord to the new reality, not the old. Wall Street is still going by the old model.
The new reality is that the Fed basically missed a whole cycle. They should have raised in 2009, 2010 and 2011. Economic growth was not powerful. In fact it was fairly weak. But it was still the early stage of a growth cycle. If they had raised rates, many would have grumbled, the stock market would have hit a speed bump, but it wouldn’t have been the end of the world.
We’d just had a crash. But by the end of 2009, the panic was basically over. There was no liquidity crisis. There was plenty of money in the system. There was no shortage of money and interest rates were zero. They could have tried an initial 25-point rise but they didn’t.
This isn’t Monday morning quarterbacking, either. I was on CNBC’s “Squawk …read more
Source:: Daily Reckoning feed
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