Are we there yet? The market sits and waits for next week as the Fed meeting approaches. Will they or won’t they? Market implied probabilities have come down as have some market prognosticator guesses on the likelihood of action. It may seem like much ado about nothing, but a paper published by the New York Fed suggested that during the period of 1994-2011 almost 80% of the total “excess stock market return” (i.e. the return earned over a risk free rate) in the United States was gathered in the 24 hours before a Federal Open Market Committee (FOMC) meeting. Coincidence? Maybe, but that isn’t going to stop Wall Street’s desire to perseverate over the matter.
Besides, remaining in this limbo economic state manufactured through monetary policy for so many years may be lulling us into forgetting that we are not in “normal” economic circumstances. Typically, the Fed raising rates is a sign of economic strength. Usually, the economic train steams higher up the hill for some time after tightening begins and it requires several actions to eventually cool activity down. Instead, we remain in the midst of a deleveraging. Our economic concern is not that we are overheating; instead, it is how to deal with the shifting debt load from the private to the public sector and bringing the amount of debt down over time. It is how to step back from extraordinary policies which took interest rates to the floor in the U.S. (and below abroad) so that when the next natural cycle comes we have traditional tools to counterbalance it. Remember, monetary policy does not create economic activity. It’s real goal is to pull it forward or push it back in time to moderate the cycle. Historically, central bank action during deleveragings have been more modest in size and duration in the understanding that the process of paying down debt defers consumption itself. Next week, much comes down to the message of whether Fed policy makers remember the road we are on.