Recently, the Fed seems quite hawkish and rushing to raise the interest rate. According to Reuters, Mr Lockhart, Atlanta Fed President, insisted the point of “lift off” is close.
Although the GDP growth remains to be over 2%, the speed of the growth is weakened, and the CPI is still far from their inflation target of 2%.
This means there are other reasons for the rate hike than just the economic recovery of the country. The Fed is actually getting pushed to raise the interest rate by some other fear: the reverse flow of the portfolio rebalancing.
What the Fed is fearing
The portfolio rebalancing is one of the effects of the quantitative easing. The low interest rates, caused by the QE, urged bond investors to move to riskier assets for greater yields or capital gains, eventually fuelling the stock market. This is what we explained in the following article:
The QE has been keeping both stocks and bonds appreciated, but once the money flow is reversed, it’s time for both of them to go down.
Why the US accepted the strong dollar
The Fed has actually been fearing this for a long time. We may remember the attitude of the US to the QE of Bank of Japan and European Central Bank.
Even though the American car makers complained about the strong dollar, Mr Lew, Treasury Secretary, insisted the strong dollar is good for the US, supporting the BoJ and ECB for their QE.
It wasn’t merely because the US wanted stronger economies in Japan and Europe but mainly because they wanted to keep the interest rate very low around the world, even after the Fed stopped the QE.
In fact, the US long-term interest rates are still low, due to the fact that it’d be irrational if the Spanish bonds were much more trusted than the US bonds in the markets.
After the worldwide QE finishes
As long as the long-term interest rates are low, the stock markets wouldn’t crash. There might be a radical correction, but as long as the bond yields are low, it should rebound. However, it would be serious when both bonds and stocks fall simultaneously.
When the QE bubble collapses, the country with the greatest advantage is the one that has raised the interest rate the most, as it has the biggest room for rate cuts and even a choice of resuming the QE.
However, the country that is the last to finish the QE would have no choice of a rate cut, as it has not time to raise the interest rate. The only choice is the QE. Therefore, there is no exit of the QE for the country that becomes the last. This is what the US wants to avoid.
The Fed’s aim
Accordingly, the Fed actually is, but doesn’t want to seem, very eager to raise the interest rate. This means they could sacrifice the economic growth or the market stability to a certain extent, and the dollar will continue to be strong. The Fed would also be more carefully watching the long-term interest rates than the inflation rate or the labour market.
Japan at risk
The country that is the most likely to be the last to stop the QE would be Japan. The QE is working in the euro-zone, so that ECB could stop the QE to have time to review the situation, but the BoJ couldn’t stop the QE within at least a few years. We explained why in the following article:
If the central banks were noticing the risk of the reverse of the portfolio rebalancing, they would compete to raise the interest rate. Some of them can rush, and others can’t.
It’s time for investors to foresee what the central banks will do, not just following their QE for investment. The easy market is over. Contemplation is necessary.