The Fed Caused This Market Sell-Off—but Not with Rate Hikes

by John Mauldin

I recently argued Jerome Powell did the right thing by raising rates a mere 25 basis points.

He did what Janet Yellen should have done years ago. And for the first time since Volcker, a Fed chair declared the Fed’s independence from the market and politicians.

Besides the Fed’s dual mandate, Greenspan, Bernanke, and, in particular, Yellen had a third unofficial mandate. It was to make sure that asset prices keep rising.

Now, of course, that’s not the way they would express it. But that is what they did.

This created a series of bubbles, which inevitably blew up. The elites made their fortunes. But those who didn’t know better and could least afford losses got screwed.

And then they had the hubris to take credit for fixing the crises they created. Exactly like the arsonist taking credit for fixing the fire he started. They have no shame.

We should not be where we are today. And we would not be here today, if the Fed didn’t screw up.

The Most Stupid Policy Mistake

Now, having said Chairman Powell did the right thing, let me tell you where he and the current Fed leaders are royally making a mess. This is critically important.

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No serious scientist would run a two-variable experiment. By that I mean, you run an experiment with one variable to see what happens.

If you have two variables and something happens—either good or bad—you don’t know which variable caused it.

You first run the experiment with one variable, then do it again with the second one. After that, you have the knowledge to run an experiment with both.

And yet, the Fed is running a two-variable experiment. It is decidedly the stupidest monetary policy mistake in a long line of Fed mistakes.

What are the two variables?

They are raising interest rates (albeit slowly) and aggressively reducing its balance sheet. I think many of today’s problems are results of this combination. It should do one or the other, not both.

Rate Hikes Are Not to Blame

Everyone blames the last rate hike for volatility. But let’s look at the other variable.

The Fed is radically reducing its balance sheet. The European Central Bank is also ending its QE (quantitative easing), as are other central banks.

In effect, they are taking away the market’s crack cocaine.

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All of the QE began to disappear worldwide toward the beginning of October. While I realize correlation is not causation, I find it suspicious that the markets turned volatile about that same time.

It makes sense that the balance sheet reduction is as responsible for the market volatility as the increased rates. If QE made the markets go up, then it’s no surprise that its ending makes the markets fall.

Let’s get real.

The Fed Funds target is now at 2.25%, barely above inflation. Zero real interest rates mean they are still giving away free money. And free money causes bubbles.

If Powell was trying to “lean into the market” and cut off budding inflation (that frankly I don’t see), he would have rates at 4% or 5%. Now that would mean we should blame the Fed for pushing us into recession and other bad things.

But, in fact, rates are still barely over inflation. Janet Yellen should have had them therefour $#%%!@#$$ years ago.

You want to castigate someone? You want to point fingers? Janet Yellen and the two previous Fed chairs are good places to start.