The Illusion of Control

Tour guides are useful when exploring unfamiliar territories.  They can help make sure a trip accomplishes desired outcomes while making sure travelers avoid places where calamitous outcomes are more likely.  While they cannot directly prevent spoiled vacations, they help improve the odds that one will be enjoyed.

America’s Federal Reserve acts as a guide for our economy.  They employ countless PhD. economists and others with a deep theoretical appreciation of the study.  In order to have a more well-rounded appreciation of America’s economy, they maintain 12 Reserve Banks, spanning from New York to San Francisco, Minneapolis to Dallas.  Yet despite the academic prowess and regional coverage, the central bank does not have as much control as one might hope.

While they did not change interest rate policies at their last meeting and are unlikely to do so at the next couple of gatherings, their latest moves have been to lower the overnight Fed Funds rate, but this has not impacted other interest rates.  The 10-year yield has risen since their first rate cut last September, and mortgage rates are following a similar pattern.  Fannie Mae (a government sponsored enterprise that buys mortgages from banks, allowing them to originate additional loans) now believes elevated lending rates will continue to act as a headwind to home sales (click here for their take from earlier this month).

Controlling yields in an economy is difficult.  The central bank has very blunt instruments with which to work, and the rest of the bond market does not have to comply with their wishes.  While the Fed can directly influence short-term rates through its policy decisions, longer-term rates are subject to a multitude of factors beyond the central bank's immediate control, including inflation expectations, economic growth projections, and global market conditions.  As the Fed continues navigating this challenging environment, it must carefully manage those expectations and communicate the inherent uncertainties in monetary policy to maintain its credibility and effectiveness in guiding the economy.  Let’s see how they fare at next week’s meeting.