Room For Error

This from Barron's.

It might pose further opportunity for the Fed to miscalculate. On one side you have people saying: 25 basis points, what's the big deal. It's talked about so long, after an initial response, it could turn out to be another Brexit moment.

On the other hand a lot of less than positive data recently hit the market not to mentioned the much ballyhooed household income increase that many believe is more hooed than bally.

2009-2009 financial crisis is still haunting markets, writes Richard Daskin of RSD Advisors in a new commentary. One by-product in recent months from new regulation has been higher short-term rates — and it has nothing to do with the Fed.

Money market fund reform, passed in hopes of avoiding the government bailouts of the supposedly risk-free investment vehicles, has already caused an increase in short-term interest rates. Daskin explains:

The upshot is that there is disintermediation going on — money is flowing out of prime funds (non government money funds), estimates are up to $300 billion. This has driven up rates on short-term non-US government guaranteed commercial paper and floating rate instruments. As money goes out of these prime funds, these obligations lose a major source of demand. Libor is up about 50-75 bps and last December’s Fed Reserve target increase of ~25 bps only explains some of it. Some market participants feel this is technical and some of the increase is going to recede. I remain a bit more skeptical. Bottom line, there is a tightening going on in the short term area of the market regardless of the September 20-21st Federal Reserve deliberations.

Daskin isn’t complaining about the regulations, but he is worried that Fed officials may hike rates on top of the recent rise, which could mean more economic dampening effects than they really intend. Daskin writes:

This has many potential effects on many areas in the financial markets, including increasing the cost of funding leverage in some closed end funds in which we invest. LIBOR is a reference rate that affects a wide range of financial products throughout the world. The fact that the spread between LIBOR and short term US Treasuries is widening is an underappreciated but important event in the markets.

He concludes:

This bifurcation in money markets/ commercial paper/ floating rate LIBOR instruments  represents another retreat from risk taking, although in the scheme of things it is probably a justified change. The monetary policymakers should pay heed though in setting rates. This is a credit tightening.