Wolf Richter: FOMC Minutes Show Fed Doesn’t Know How to Unscramble the ZIRP Omelet

By Wolf Richter, a San Francisco based executive, entrepreneur, start up specialist, and author, with extensive international work experience. Originally published at Wolf Street.

The minutes of the FOMC’s March meeting make clear just how hard it is for the Fed to even think about the possibility of unwinding what they’ve wrought. After six-plus years of interest-rate repression, absurdity has become the established norm. Now they can’t even figure out how to get out of it without bringing down the whole construct.

They handed the fruits of their monetary policies to folks who bought assets with them. Assets values have skyrocketed, yields have plunged, and risks have disappeared from the calculus. You can still get run over by a car, but you can’t lose money in stocks or junk bonds. That’s the established norm.

This stream of money created asset price inflation and funded the fracking boom, the tech bubble, and a million other things that produced a lot of supply. But demand remained lackluster because they didn’t hand this moolah to the folks who’d spend it on gadgets or food or gasoline, the folks who’d actually create demand. The economy languished, and consumer price inflation, though bad enough for consumers, remained mostly below the money printers’ lofty goals.

Now the Fed is trying to figure out how to unscramble the omelet. Meanwhile the ECB and other central banks are adding to it, accomplishing an absurd feat: even the crappiest sovereign bonds – except those of Greece – are soaring, and yields are plunging, many of them into the negative.

Then on Wednesday, a new thing happened: Switzerland sold 10-year government debt at a negative yield. They’d been selling debt at negative yields for a while, but with a 10-year maturity. No country had.

The little country with piles of money is defending itself against the influx of euros by repressing interest rates and making it in theory unpalatable to hold Swiss francs. But it isn’t working. What dreadful thoughts are rumbling through the heads of these investors that would scare them into lending their money to the Swiss government for ten years, not to earn a fair return, but for safekeeping apparently, and they’re even willing to pay for it!

Germany’s 10-year debt is following closely behind, yielding a still positive but practically invisible 0.15%. About €1.8 trillion in Eurozone sovereign bonds entice “investors” – if you can call them that – with negative yields, which now includes Spanish 6-month T-bills.

These inflated debt prices are great for borrowers. They’re flocking to Europe to sell debt to investors desperate to escape the negative yield trap laid out for them by Mario Draghi. Junk-rated corporate America caught on to it in no time [read…  Dumping American Junk in Europe, Draghi Asked for it].

And Mexico, which had its share of debt crises by borrowing in foreign currencies, got wind of it. It is now hawking 100-year euro bonds to these desperate investors, enticing them with a yield of about 4.5%. “Pretty attractive,” is what Marco Oviedo, chief economist for Mexico at Barclays, called them. He expects healthy demand. An awesome deal in a risk-free environment.

Years of promised QE, actual QE, near-zero or negative interest rates, and the idée fixe that these conditions are permanent have sent asset prices soaring. Many, like German stocks, are disappearing from view.

Same in Japan, where the Bank of Japan just voted 8-1 to push QE at full tilt. It’s buying every Japanese Government Bond that isn’t nailed down. It’s buying J-REITs and equity ETFs every time the market dips to make it head the other way. Absurdities are playing out with increasing intensity. The JGB market has dried up under the BOJ’s relentless bid. And even conservative pension funds are dumping JGBs into the lap of the BOJ to buy equities at inflated prices.

And inflated they are: the Nikkei is up 135% in three years though the economy has languished. Real household incomes have been whittled down by a bout of inflation and a sales tax increase. The Olympics are coming, real estate values are soaring in Tokyo and some other places as foreign buyers and developers are pouring in, armed to the teeth with cheaply borrowed money, even as the hollowed-out middle class gets to hold the bag.

Oh, and Chinese stocks! Shanghai’s SSE Composite Index has nearly doubled in 12 months.

Absurd monetary policies are easy to start, the announcements are fun, and the market rallies they engender are vertigo-inducing. Central bankers look like heroes, as if they’d single-handedly saved the economy or something. Now there are financial bubbles everywhere. Mega-fortunes are tied up in them. And home prices have soared.

Unlike financial assets, homes are something people need. When prices get to the point where only free money makes ownership possible for the middle class, and when even rents become unaffordable for many people – then there are some serious problems in the main-street economy.

But how the heck do you stop this madness before something BIG breaks? How do you get out of it without bringing down the whole construct? You’d think that six-plus years of these policies would have given central bankers enough time to figure it out. But no.

The Fed doesn’t know how, according to the minutes from the March FOMC meeting. To its credit, it’s at least discussing it. But it doesn’t even know how to raise interest rates, now that the huge balances of excess reserves the banks keep at the Fed render the traditional way ineffective.

So they’re playing with novel mechanisms. But they might pose “risks to financial stability” – market swoons, in Fed speak. One of these mechanisms would be to sell some assets that mature in a relatively short time. A minor move, a total no-brainer, you’d think. But even the mere announcement, according to the minutes, “would risk an outsized market reaction….”

The “public” – the speculators the Fed has been feeding with free money – might see this as a “signal of a tighter overall stance of monetary policy than they had anticipated.” And it could make this whole construct come unglued. The mere announcement of such a minor move!

At least, FOMC members are discussing an exit, even if they have no clue how to get the financial markets through it in one piece. Other central banks are now focused on getting even deeper into it. They don’t have time to contemplate what comes after. And none of them have a plan for the moment something BIG malfunctions as a result of their absurd policies.

The ECB and other European banking regulators slept through it. But the competition folks at the European Commission have gotten wind of it. And they have real teeth. Read… This Could Sink Banks in Greece, Portugal, Spain, and Italy

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. Ben Johannson

    Best tool available is to raise the maintennace rate concurrently with the discount rate, moving both the floor and ceiling upward. If raising rates is that important (as the governors seem to believe) then do this and worry about the details later.

    1. Ben Johannson

      Looking at the minutes of rhe meeting this appears to be the plan, whenever they decide to lauch.

  2. MikeNY

    Yes, the hope and prayer was always that the ‘real’ economy would catch up with asset prices, thus retroactively ‘justifying’ them. We were to be saved by the wealth effect. The problem is, what happens when there is such enormous concentration of wealth that it has lost its customary effect? That is where we are now, and IMHO, it’s difficult to see how the old models will again work without a massive redistribution of wealth.

    I don’t expect the world’s central banks (as the Swiss Guard for the world’s oligarchs) to entertain this framing of the problem anytime soon. So I look for financial repression as far as the eye can see. Of course, something may (probably will) break in the meantime, but where and when is anyone’s guess.

  3. financial matters

    I think the problem is also reflected in one of the links for today: ‘Dimon, now Summers: There’s a liquidity problem CNBC (Furzy Mouse)’

    We need to get the leverage out of assets and distribute liquidity to the bottom half of the economy. (Probably not quite the way Dimon is looking at it, he’s probably happy to keep the liquidity at the 1% level)

    The Fed needs to take its employment mandate more seriously and look at it in terms of a living wage. This would include affordable housing which would be counter to its current asset appreciation policies.

    This would help create true demand which could put the stock market back on a realistic footing instead of a bubble footing.

    1. susan the other

      Paying back our debt to people and the environment is the only way to balance economies. Wolf should look at it this way: Asset values have skyrocketed, but in reality they were always suppressed because the true value of assets was never calculated to include the externalities. The environmental costs and the human costs. So of course the whole thing is totally out of whack. But now that these assets are firmly in the loving hands of their creators, the 1%, they can go ahead and state their true value in terms of “money.” And all that money will never balance out again unless it is reinvested back into the environment and the people from whence it came. ASAP. So this action is a tad above the Fed’s pay grade. The Fed’s mandate is a comedy routine. Who can do this real work for us?

      1. financial matters

        The Fed can be creative but has used this mostly for the financial industry. Congress has a lot of good options and hopefully will start paying attention to Stephanie Kelton and be able to come up with a better mantra than ‘we are out of money’ when it comes to social programs.

        Grassroots cooperative movements can be very strong and lead to political change.

        Stathis Kouvelakis had this to say in a recent Jacobin interview ‘Dangerous Days Ahead’

        “As for its political project, I’ll tell you something that doesn’t express a personal view so much as a wider search that’s currently taking place. Syriza isn’t the be all and end all. There’s also a kind of “network building” from below within Greek society which has been going on these last years, with all sorts of efforts at self-organization, and of movements that while working at the local level often also establish flexible relations among themselves.”

    1. Jim Haygood

      One can make a TON of money shorting the peak. But I have never found a quantitative indicator for doing it. Ultimately, it’s about judging the madness of crowds.

      My sense is that we’re not there yet. When it becomes patently obvious to every rational human being that stocks can only ever go up, that’s the day you sell short.

      Or when the good Dr. Hussman finally gets institutionalized for his own safety.

      1. craazyboy

        Ya, picking peaks is harder than picking bottoms. There is the zero bound – or 666, whichever happens first.

      2. Ed S.


        Indulge me — I’m going to tell you a brief story (that also happens to be true):

        August 1998. Been working for about 7 years and have a modest nest egg in my 401k fully invested in SP500. Walking through the Loop in Chicago with my girlfriend on a visit. Start eavesdropping on two young but well attired/groomed women walking along. Look like maybe assistants at an ad agency or legal secretaries.

        They’re talking money and one says to the other (I paraphrase — it was a lot of years ago) – “You NEED to invest in stocks. The stock market can never go down.

        Closed out my positions in November — which I’ll note was fully 15 months before the peak.

        We’re not there yet with stocks.

        And agree with the Dr. Hussman’s comment.

        And per your comment below — I’d vote for that. A timid “one and done” hike and when the world doesn’t blow up it’s time to light the afterburners.

        1. Jim Haygood

          It’s precisely because it doesn’t make sense (everybody knows ‘rate hikes are bad’) that the opposite might happen.

          As in Gulf War I (Jan 1991), when everyone expected markets to crumble, but instead they took off with a bang.

          If markets made sense, any idiot could figure them out. ;-)

  4. Jim Haygood

    ‘But how the heck do you stop this madness before something BIG breaks?’

    We were discussing this at the dinner table last night. Currently a stock valuation tool, Shiller’s CAPE, is at 27: about the same as in late 2007, but still well below its all-time record of 44 at the peak of the Internet bubble.

    A possible scenario, to which I ascribe about a 30% probability, is that a couple of timid rate hikes later this year do nothing to slow the asset bubble. It’s too little, too late. So we revisit the Internet bubble madness, and maybe the Bubble II real estate froth too.

    Meanwhile, Nikkei 20,000 and DAX 12,000 are done deals, and so might be Nasdaq 5,000 when today ends. Anything is possible now, my brothers, as the late Saddam Hussein used to say.

    Got biotechs?

    1. craazyboy

      Not sure I’d use the iBubble as reliable either. In that case everyone was using PEG as a valuation measure instead of PE. In other words, if you can convince yourself the company has a exponential growth outlook – like being one of the elite 100 startup companies with an Amazon.com clone biz model – then you can easily justify paying PE ratios of 100 or some such thing. There was also quite a bit of creative wiggle room in growth projections too – I recall at Peak AOL, the valuations implied AOL needed to triple the population of the planet at current subscription prices to finally reach a steady state PE of 15. Then there was the whole hardware industry – from Telecom to high speed router chips – that had similar valuations. I remember you coulda shorter Northern Telecom at 200 all the way to zero. Just that you never think of shorting in times like that.

      1. craazyboy

        Plus this go around I have this irrational fear that HFT robots won’t be satisfied with being market “liquidity providers” and their Overloads may even program them that “Greed is Good” and the brainless monsters short the hell out of the market all the way down to Dante’s Lowest Ring of Hell.

        1. Polar

          Yep. Remember the flash crash when some stocks had NO bid. People make the mistake of believing that there is a rational top and rational bottom and that if stocks fall, they won’t fall that far. We’ve totally screwed up all the correlations so no one knows what will happen in a world where Spain (who’s debt to GDP exceeds the Euro crisis levels) borrows at sub zero for six months.

      2. Ed S.

        I remember you coulda shorter Northern Telecom at 200 all the way to zero

        As always, the problem is timing. Just ’cause it’s absurd at 200 doesn’t mean that it can’t go to insane^2 and hit 400.

        QCOM went from (a split adjusted) $3.75 in January 1999 to $88.06 on 12/31/99. You read that right – for those of you too young to remember the insanity.

        1. craazyboy

          Nokia was a great short too! About 30% of Janus Funds total assets were in Nokia. Diversification be damned when you find a good one!

      3. Jim Haygood

        Take a look at this chart of the NYSE Arca Biotech index (BTK), and tell me whether it rhymes with the Nasdaq in the late 1990s. I mean, even the numerical levels match:


        BTK 5000, comrades. We’ve earned it.

        Just wait till the rumor starts that they’ve modified the human genome for eternal life. BTK 20,000 will be in the bag. And we’ll be holding it.

        1. craazyboy

          Looks similar pricewise, except that 90% of biotech doesn’t have any living customers yet. Then there are the lengthy clinical trails for all except the lucky few like Monsanto. At least in the 90s you had the entire corporate world doing record amounts of cap sending in IT, which gave some underlying credence to the tech boom.

    2. cnchal

      A possible scenario, to which I ascribe about a 30% probability . . . is that the Fed will do one rate hike, Mr Market will fake a heart attack, and the Fed will backpedal so fast, it will fall over backwards and crack it’s skull, and be in a coma for years.

  5. Fair Economist

    Seems the MMT’ers are right. The government doesn’t need to borrow, it can just print money. That’s what these zero-interest government bonds work out to.

    1. Ben Johannson

      Yes, there’s no functional difference between bonds and reserves at the zero lower bound. It becomes a question of which our government wants more of in the banking system at any given time; if the Fed governors understood this they wouldn’t be so concerned about Something Big happening. Instead their worrisome behavior creates conditions that frighten the typical underinformed investor into doing Something Stupid.

  6. different clue

    I am not an economist or a stockbroker or a trader or big operator or anything. I am a biweekly wage technician in a hospital. But I do know this: during all the amazing ups and downs being reminisced about here, the number of sardines in my cans of sardines did not change up or down by so much as one single sardine. Not once. Not in all my several hundred cans of sardines over the years. Is there a lesson in that somewhere?

  7. mpr

    A stunningly uninsightful article. With no logical argument whatsoever, the author assumes current interest rate dynamics are somehow pathological, and spouts nonsense about a ‘fair’ return. The idea that low and negative interest rates may be appropriate and may be telling us something about the real economy apparently hasn’t crossed the author’s mind

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