E Top Ten Reasons The Fed Raises Interest Rates When There Is No Inflation

Why would the Fed raise interest rates where there is little inflation? This is an important question to ask, I think, because the Fed is tightening rates while tax revenue is down and while any tightening could throw the nation into recession.

I believe there are at least ten top probable reasons why the Fed is raising rates, starting with the December, 2016 increase:

1. The Fed is misreading the effective demand limit, as assessed by Edward Lambert. Christmas shopping was below par and should sound a warning. The chart by professor Lambert explains the effective demand limit and the closing of the business cycle. Inflation is simply not a concern to Dr. Lambert:

By Permission of Edward Lambert

2. The Fed cannot raise rates significantly to stop rising inflation later on. That tool that Paul Volcker possessed, has been taken away from the Fed due to the massive demand for collateral for loans, deals, derivatives, bank capital requirements, etc. This early attempt to raise rates is, for me at least, a proof that collateral and clearing houses do matter now, in a way that was not even foreseen before asset backed collateral failed in the Great Recession. While holding bonds used as collateral to redemption insures receiving the full dollar amount you paid for the bond, the market price of bonds are marked to market by the clearing houses daily. The Fed does not have the power to tackle an inflation that existed in the 1970's where prices for goods and services changed multiple times in a week! Therefore, the Fed is paranoid about inflation prematurely due to this limitation on its powers.

3. The banks have bet on low rates and continue to bet on low rates and counterparties often take the fixed high interest side of swaps. This is not always the case, as Japanese banks have begun taking the fixed higher side of the bet. However the swap or loan is arranged, the counterparties to the lending banks put up collateral, bonds. It is necessary that the counterparties be sound and here are quotations showing why. Banks must know where their counterparties stand:

Especially in times of market stress, multiple collateral settlement fails or non-response to queries might suggest underlying problems. Even if not indicative of a failing counterparty, fails can still damage a firm’s reputation, making it hard to build relationships and win business. Replacing expected collateral in the event of a fail can be a significant funding cost, depending on liquidity levels and prevailing market conditions, with knock-on implications for other transactions. For banks, persistent unresolved fails could represent uncollateralised derivatives exposures, leading to extra capital charges under Basel III...
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Disclosure: I am not an investment counselor nor am I an attorney so my views are not to be considered investment advice.

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