Major Fed Myth: Debunked
The Fed is reactive in setting rates – not proactive
by Bob Stokes
Updated: December 29, 2022
The days of near-zero interest rates are long gone -- at least for now.
As we look back on 2022, we know that it's been a year of rising interest rates, and many observers say it's all due to the Fed.
But it's a flat-out myth that the Fed determines the trend of interest rates. The market does. The Fed merely follows.
Here's a chart and commentary from the December Elliott Wave Theorist:
The chart updates the Fed's interest-rate activity since mid-2021. As you can see, the Fed's rate changes have continued to lag rate changes in T-bills as set by the market. The Board's decisions are not magical or even thoughtful. They look at the market rate, and they adjust the Fed Funds Rate accordingly. That's all there is to it. That's all there ever has been to it.
So, given that the market sets rates and the Fed follows, a key takeaway is that the Fed's interest-rate actions produce no outcomes (for example, "stepping on the brakes" of the economy) that wouldn't have happened through regular market forces.
Other central banks around the world also lag the market. Consider the European Union. Here's a historical snapshot from Robert Prechter's book, The Socionomic Theory of Finance:
The chart plots monthly data for the interest rate of the freely-traded, 3-month euro generic government bond versus the European Central Bank's (ECB's) main refinancing operations rate, which is Europe's equivalent to the U.S. federal funds rate. As these graphs show, rate-setting actions by the ECB have lagged the freely traded debt market at all seven major turning points in interest rates since 1999. The lags vary from one to ten months, and the average lag is 5.3 months.
You can find the same principle at work in the United Kingdom, Australia and other global central banks.
It may be difficult for central bank watchers to latch onto the idea that markets guide central banks rather than the other way around. Yet, no data show otherwise.
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Is A Perfect "Balance" of Stocks, Bonds and Precious Metals Possible?
Many financial advisors would answer "yes." They might even suggest that you add more assets to the mix -- such as international equities, REITS and perhaps other assets.
But, in Elliott Wave International's view, no matter how carefully an investor constructs a "balanced" portfolio, it may offer little protection during a major financial downturn.
In truth, "balancing" a portfolio is a poor substitute for knowledge of financial markets.
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