THE BLOG
01/27/2016 12:59 pm ET Updated Jan 28, 2017

Fed in a Box

The Fed is caught in a box of its own making. They insisted that inflation was on the rise, and job gains reflected strength in the economy. And they wanted the world to believe their previous promises that they would raise interest rates. So they raised rates. And... nothing happened!

That is, nothing happened in the bond market. In fact, across the spectrum rates have either remained the same or declined. Mortgage rates are slightly lower than last December when the Fed raised the Fed funds rate for the first time in more than a decade. Other rates that impact the economy, such as credit card rates or auto loans, are basically unchanged. Savers aren't earning more interest. And the 10-year Treasury note, a key benchmark, remains at the same level as before the Fed's decision.

In other words, the bond market isn't listening. But the stock market is. It's disputing the Fed's assessment of a strongly growing economy. The rest of the world's central bankers are trying to stimulate their economies, but by raising rates the Fed implied our economy was strong enough to get rates back to normal. And "normal" meant "higher."

The one place where market-based rates have been rising is the "high-yield" credit sector. There rates have risen sharply to an average of over 10 percent, reflecting fears that an economic slowdown, and lower oil prices, could cause defaults by some of these borrowers.

One thing the Fed's initial rate hike did was to make the U.S. dollar even stronger, more attractive -- more highly valued against other currencies. That makes our exports more expensive -- and we lose sales to competitors.

The Fed's action to raise rates may actually contribute to declining earnings, and a falling stock market and a slowing economy. The Fed is caught in a box of its own making. And the Fed is pretty much alone inside that box!

Other central banks -- ranging from Japan to Europe to South America, and even China -- are cutting rates and pumping money into their economies to stimulate growth and stave off recession. But despite several years of those activities, Europe remains mired in slow growth, and even negative interest rates in some countries. Japan still has zero growth. And China is learning it's not so easy to control a market by talking about growth, or printing money to incite economic activity.

Is the Fed big enough and powerful enough to move against these global forces of slowdown and deflation? We have been accustomed to calling our Federal Reserve the "all-powerful" Fed. But just like the Wizard of Oz, the curtain may be lifted to reveal not such a powerful force after all. And that's The Savage Truth.