When Will the Fed Raise Interest Rates? When the Market Says So

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When Will the Fed Raise Interest Rates? When the Market Says So
The Federal Reserve Bank's interest rate policy is not as "independent" as most people think

By Vadim Pokhlebkin
Thu, 30 Aug 2012 17:15:00 ET

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You probably know what event dominates this week's U.S. economic calendar: the August 31 Federal Reserve chairman Ben Bernanke's speech at the policy meeting in Jackson Hole, Wyoming..

In a credit-based economy like ours, one that revolves around lending and borrowing, interest rates are a hugely important component of the overall economic picture. So it's no wonder that Wall Street and Main Street both pay close attention to the Fed's interest rates decisions.

Now, the Fed has already said that it would keep interest rates where they are, at 0%-.25%, through 2014, and maybe beyond. That makes it sound like the Fed is full in control of rates. But the fact is that the Fed is prompted into action by an outside force: namely, the U.S. Treasury market.

Indeed, usually the Fed simply follows the yields: T-bill yields, to be exact. Yields change daily, and central banks don’t control them: Yields (and prices) are set by the bond market. And if you observe the timing of the Fed's interest rates decisions, you will notice that usually, it doesn't lead the bond market -- it only follows. In other words, it reacts to what T-bill yields dictate. This is a chart we've shown to subscribers before:

The Fed is not alone in following bond yields. We've made similar observations before about the European Central Bank and Reserve Bank of Australia. (You may have also seen this article on Yahoo! Finance by Alan Hall, a lead researcher for the Socionomics Institute, EWI's sister organization.)

To raise or lower interest rates is the single most important tool by which the central bank's "potent directors" are said to control our economic future. They carefully watch economic indicators, and deftly adjust interest rates accordingly -- or so goes the mainstream thinking.

But now that you know that the Fed is not nearly as "in charge' as it appears, is the outcome of their August 31 meeting really that important?

To find out where the markets and economy are likely headed next, read the new, August 2012 Elliott Wave Theorist by Elliott Wave International's president Robert Prechter. Start here, risk-free:

Tags: Ben Bernanke, monetary policy, Treasury bills (T-bills), Treasury bonds, treasury yields, U.S. Federal Reserve (the Fed)

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