Source: Investopedia

Takeaway: The Fed has outsourced policy to markets.

I mean it, a five year old could run the Fed. It’s a really simple job. Watch what the market does. When it throws a tantrum, cut rates. How does a five year old understand when the market is throwing a tantrum? There are three easy indicators.

Step One: Watch the 10-year Treasury

When the yield on the 10 year falls below Fed funds, markets start to worry. When the 10 year falls below the 2 year, markets really worry. Everyone refreshes their reports about inverted curves and recessions. This leads to step two.

Step Two: Watch the Stock Market

Once the curve inverts, the S&P will start to sell off. When the S&P starts to approach correction range and the VIX starts to spike, the alarms bells at the Fed start to ring. This brings us to step three.

Step Three: Watch the Fed Futures

After we have reached step two, inevitably, the bond market starts pricing in Fed rate cuts. This happens well before any Fed member speaks up to say they might consider cuts. No, the markets dictate that a future cut is “priced in”. Only after this happens does the Fed changes its position from “no cut at the next meeting” to “we are evaluating recent events”.

A Five Year Old and a Bloomberg

Our five year old only needs access to a Bloomberg terminal to run the Fed. He or she only need to know how to type a few short “words” to get all the information one needs.

First, our child prodigy needs to be able to type “C15“. This will show the shape of the yield curve. If the shape of the line is going down and to the right, test one has been passed.

The next command is a little tougher but not too hard. Our precocious Chair needs to type “SPX” then hit the button that says “Index” then type “GY. So three letters, a keystroke, and two more letters. This shows a chart of the S&P 500. Again, if the line here is going down and to the right, the second requirement is in place.

Finally, our five year old needs to type “WIRP. This is the screen that shows the odds the Fed will raise at the next meeting. If the percentage shown is 75% or greater, test three has been passed and the Fed can cut rates at it’s next meeting. If it says 100%, then the Fed can choose to cut immediately!

And that’s all there is to it. We could also design a robot to do it, but then people would complain about AI stealing more jobs. Plus, a five year old is cuter than a robot, so I vote to let the kid do it.

Should the Fed Abdicate Its Role to Markets?

Ah, now we’re asking the right questions. Of course, the Fed shouldn’t abdicate its role to markets. The Fed is supposed to be independent. It’s supposed to be wise. It’s supposed to consider the long term and not just the next trade.

It’s also supposed to realize that Fed policy can’t do much to counter a supply shock. Nobody in the real world cares that interest rates are lower. You’re not going to get on a plane because the Fed cut rates! It’s not going to pay your bills if your employer closes the factory and tells you not to come to work.

You could argue it’s a no cost option by the Fed if you believed that when the virus is contained they will raise rates back to where they were. But nobody believes that! Nobody.

Instead of buying a no cost option, they wrote a put for free. They gave away something valuable for a threat that may not exist. If a month from now it turns out we only ended up with a couple thousand cases, then they gave away two of their few remaining cuts for a real emergency for no reason.

What’s A Better Alternative?

This might be too much for a five year old, but certainly a well educated 20 year old economics major could tell you that you address demand shocks with monetary policy and supply shocks with fiscal policy.

What is the benefit of using fiscal policy? You can better target those who need immediate help. For example, the government can send a $1000 check to anyone who was forced to miss work due to their employer closing its doors or scaling back hours.

Think of a restaurant who had a sick employee in the kitchen and has to shut down for a week to detox the place idling 50 other workers through no fault of their own. The government could also give tax refunds to small businesses that were forced to close for a period of time because a sick employee came to work and infected the plant.

The side benefit of moves like this is it would discourage people from showing up to work when they suspect they’re sick out of fear of missing a paycheck, especially if you can design a fraud proof way of paying truly sick workers to stay home.

While normally one might suspect government is too partisan to agree on something like this, especially in an election year, I suspect the opposite. Would the Democrats really want to obstruct Trump from getting money to sick workers? They would lose that PR battle badly.

And if the Democrats propose it first, Trump has to say yes or risk looking terrible if the disease continues to spread and tanks the economy. It’s an obvious bipartisan measure and would do a lot to alleviate panic.