Econintersect: There is a common wisdom that the Federal Reserve sets the short-term interest rates for the U.S. However, there are studies that question that wisdom. One of them has shown that the market changes in short-term rates always leads the interest rate changes by the Fed. The authors of this study conclude that the Fed does not set interest rates but that the market does and the Fed merely follows. This theme is developed in the following video.
The following 17-minute video covers the 22 November interview of Alan Hall (Socionomics Institute) by John O’Donnell and Merlin Rothfeld of Power Trading Radio.
The correlation is extremely strong to support the thesis that the Fed follows the market and that it is the market that sets short-term interest rates. Alan Hall calls the forces determining interest rates to be "unconscious social mood". This is analogous to the "invisible hand" metaphor of Adam Smith from 240 years ago.
Econintersect would point out that others might interpret the data differently. The alternative might come from those who would say this is a good example of the rational expectations of the market participants (collectively) - the moves by the Fed are simply being correctly anticipated. Those proposing this explanation would point out that the Fed doesn't always follow so the market should not be considered to be forcing the Fed's hand. Examples of market moves that were retraced because the Fed did not move are seen in December 2001, December 2005-January 2006, October 2006, April 2008 and 4Q 2008. So most of the time the market correctly anticipated moves by the Fed, but the exceptions prove that the "hand of the Fed" was in control and not the "invisible hand" according to this alternative view.
Econintersect would also point out a possible rejoinder from the socionomics viewpoint, although this has not been bounced off Alan Hall to get his concurrence. The exceptions pointed out above could be occassions where the invisible hand was moved by "animal spirits" to excessive action and cooler heads prevailed to move back to more appropriate social mood.
Perhaps the "invisible hand" can have tremors?
- Social Mood Is the Real Governor of the Federal Reserve (Alan Hall, Yahoo Finance, 05 July 2012)
- Alan Hall Talks Social Mood and the Fed Interview with Power Trading Radio Alan Hall, Socionomics Institute, 06 December 2013)