Fed to Keep Rates Low for Some Time; Deja Vu All Over Again

Several Fed officials made speeches yesterday reiterating their support for keeping rates at 0% for the foreseeable future. They cite unemployment, unused capacity, and low inflation. I did a quick search and found that this is precisely the language used to justify past low rate policies - the same policies that contributed to asset bubbles.

There is no doubt that the rising stock market has no basis in fundamentals, and like the housing market in 2005 is being fueled by monetary and fiscal policies. The problem with that is what happens when  the monetary and fiscal environment changes. As we saw in 2007, the housing bubble couldn't survive rising interest rates and soaring oil prices.

Take a read of these prouncements and see if you can determine what year we are in:

"'We were clearly surprised,'' Mr. Dudley acknowledged. But he said the Fed continued to emphasize the same concerns it has for the last several months -- inflation that is almost uncomfortably low and ''slack'' in the economy.

''We think nothing fundamentally has changed,'' Mr. Dudley said. ''The Fed thinks inflation is too low and it wants inflation to go up.''

Mr. DiClemente of Citigroup agreed, though Citigroup recently moved up its own prediction of when the central bank would start to raise rates to late this summer from early next year.

''People have been arguing that the Fed was behind the curve,'' Mr. DiClemente said. But he added, ''We still have some hurdles before there can be any tightening.''

This one is from a NY Times article in 2004.

Here's another one:

"The argument that the Federal Reserve needs to act now to "be ahead of the curve" is unconvincing after three years in which being ahead of the curve would have meant raising interest rates while inflation was actually falling. If inflation does turn around, it is likely to rise very slowly, giving the Fed ample time to respond. Confidence in the Feds long-term anti-inflationary stance, reflected in the remarkably low inflation expectations of less than 2% implicit in the Treasury Departments inflation-protected 10-year bonds, is further reason for the Fed to recognize that there is no urgency in raising interest rates."

This one is from an article written by Martin Feldstein and published in the WSJ in 1999.

Concern that global prices of shares and property have risen to unsustainable levels is “premature” and spare production capacity will help contain inflation, said David Riley, head of global sovereign ratings at Fitch Ratings.

“Some concerns about the asset-price inflation are overstated,” Riley said today in a phone interview from Seoul. “Policy makers want to reflate asset prices as part of the recovery; if that starts getting out of hand, then you can get worries about future asset bubbles. These concerns I think are somewhat premature.”

From Bloomberg today, November 11, 2009.

The common thread is clear to me. Low price inflation leads to low interest rates which leads to asset growth and asset bubbles. No one recognizes the bubble until it has popped,with all due respects to Mr. Riley from Fitch Ratings.  Let's look at Fitch's pronouncements from 2006.

That doesn't mean you shouldn't rise some of the bubble on the way up. Just be aware that at some point it's going to turn and that you don't want to take the ride down.


Sam Cass
Sam Cass: Sam Cass, MBA, JD, University of Texas at Austin. Always a fan of Leonardo Da Vinci.

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  • Rajiv Gothra

    November 12, 2009

    We all missed the bottom, but those who are calling it a bubble are those who are hoping to get a second chance. It isn't going to happen. The stock market is supported by strong fundamentals at companies and a declining dollar (= strong USD-denominated revenue). The move is unprecedented, but it does not signal a bubble.

  • Sam Cass

    November 12, 2009

    "The stock market is supported by strong fundamentals at companies and a declining dollar"

    The fundamentals are not that strong. Income has only increased at companies who have done severe cost cutting. Consumer spending, which accounts for 75% of the economy has collapsed. Unemployment is above 10%. The only thing propping up this economy is government stimulus and low rates, both of which can't last forever and both of which are causing their own imbalances.

    We're like a sick person who received a steroid shot and now believes they are cured.

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