On February 25, I wrote this report: Yellen Says No Rate Hikes, As I Knew She Would.
Yesterday, the Dow was up 227 points at the end of the day — a swing of over 400 points. For what? For nothing. No action taken on rates.
Of course there was no action taken on rates. There was no way the FED was going to raise rates.
It is time to reproduce what I published on February 25. Nothing has changed.
The Federal Reserve System cannot raise rates. It only pretends that it can.
It cannot raise short-term T-bill rates. It has no power over T-bill rates.
It can raise the Federal Funds rate: the rate at which commercial banks lend overnight money to other commercial banks. Problem: banks no longer lend overnight money to other banks. There is no demand for these loans. The commercial banking system has $2.6 trillion in excess reserves at the FED. No bank needs to borrow overnight money in order to meet its reserve requirement temporarily.
The FED pays up to 0.25%. How can it afford to pay 1% or more on excess reserves of commercial banks? The FED does not buy any investment with this money. It just sits in the FED’s digital vault. It is legally the same as currency sitting in a local bank’s vault.
The FED must pay FedFunds interest out of its profits. Here’s the deal. Every dime that the FED pays to the banks on excess reserves, it cannot return to the Treasury at the end of the FED’s fiscal year. So, the federal deficit goes up if it it pays more interest to banks.
Also, if banks are willing to hand over $2.6 trillion to the FED for 0.25%, how much more will they hand over at (say) 1%? My prediction: lots more. So, the FED will pay out even more money in interest.
The FED has no control over long-term rates. T-bond rates have been falling. But the FED has not been buying T-bonds. Rates have been falling, even though the FED has pulled out. Why won’t they fall even more?
So, exactly how will the FED raise rates? Which rates?
By waving a magic wand?
The FED can announce: “Short-term rates, rise!” Then what will happen?
This is why Dr. Yellen made her announcement about the delay in the rate hike.
She will make a similar announcement in six weeks.
I have yet to see a single article in the financial media that explains exactly how the FED will raise rates. I am certainly willing to re-consider my position. But I need arguments. I have seen no arguments.
For an account of yesterday’s action, click the link. The FED did nothing. This surprised investors. It did not surprise me.