The following sounds like the plot to Mel Gibson’s 1996 movie “Ransom”, but could represent a summary of events last week.

“The US economy is the biggest in the world. They built their fortune by working hard (and a little Quantitative Easing). They have a great Central Bank (the Fed). One day, the Fed is expected to increase interest rates, but China devalues the Yuan and markets are all over the place. The Fed is willing to raise rates, as their economy is recording great growth and employment is strong. But a bunch of economists, investment bankers, and even a credit ratings agency orchestrate a “ransom” of further market volatility. What will the Fed do?”*

The events of last week (to a conspiracy theorist) might seem similar to the Fed being held to “ransom” by market participants. It’s being called the “Yellen Put”, as the Fed chief gave in to market pressure.

As we know, the Fed left interest rates on hold, citing international worries and weak inflation.

Unfortunately for the Fed, it would seem in the process of not changing rates, they have given up some credibility, and postponed market risks for an even greater problem in the next few months.

The “Yellen Put” means market participants will continue to take greater risks as they know the Fed will provide a price floor (the put) for asset classes. This all makes me think of how a ransom paid rewards or gives positive reinforcement to the extorter.

I know that comparing the events of last week to a ransom is harsh, but consider the following:

• Futures markets were pricing in a 70% chance of no change in rates.
• A survey showing 12 out of the 22 US Federal Reserve primary dealers agreed.
• Yet nearly half of economists surveyed expected a hike.

Why were nearly half of economists expecting rates to rise? That is because they look at the economic case for a hike, as opposed to bullying the Fed into submission. Have a look at a summary of US economic indicators:

• Retail sales in the US climbed for the second straight month
• The jobs market is robust, and employers are starting to find it hard to find workers. The Beige Book’s most recent survey also showed growing wages pressures.
• Unemployment is at its lowest level since 2008 at 5.1%
• Inflation is at 1.8%
• The US economy itself has grown faster than previously thought with an annualised growth rate of 3.7% (vs initial estimates of 2.3%). With higher exports, and stronger consumer and government spending adding to the mix.

Sounds pretty solid right?

What was interesting was how vocal the various investment banks and trading houses were about why the Fed should leave rates alone earlier in the week. I mean, how dare the Fed spoil the zero rate party (and remove the “Yellen Put”)?

Some of the comments days before the meeting included the Goldman’s Chief saying “US economic data don’t support the case for higher interest rates”. JP Morgan’s Jamie Dimon echoed a similar view at the Detroit Economic Club, in direct contradiction to his Economist. One of the 22 primary dealers that trade directly with the Fed, Barclays’ Chief US Economist said “China’s decision last month to devalue its currency will help keep the Fed on hold”.

Even credit ratings house Moody’s weighed in, releasing an announcement the day before the meeting “a Fed move will contribute to downside risks for some emerging market sovereigns”. They pointed particularly at Brazil, Russia, Turkey and South Africa.

What did the Fed do?

The Fed paid.

The Fed left rates on hold, allowing the zero interest rate party to continue a little longer. In their policy statement, the Fed said that recent global developments “may restrain economic activity somewhat and are likely to put further downward pressure on inflation.” Yields on US short end Treasuries fell below zero as an influx of cash and pent-up appetite for safe assets led investors to accept negative returns.

After the event, JPMorgan said the Fed’s statement was “good for bonds”. Of course it was. They paid the ransom. The market now knows the Fed’s “Achilles heel”. With the five largest Wall Street firms generating some $73.7 billion from trading last year (two-thirds from fixed income units), what do you think they want the Fed to do? What do you think will happen next meeting?

Ms Yellen, just rip the band-aid off.

*“Tom Mullen is a millionaire, he built his fortune by working hard. Along the way he learned how to play the game. He has a great family. One day his son is kidnapped. He is willing to pay the ransom but decides to call in the FBI, who manages to go into his home secretly. When he goes to make the drop something goes wrong. The kidnapper calls him again and reschedules it. On the way Mullen decides not to go and appears on TV saying that the ransom he was going to give to the kidnapper is now a bounty on the kidnapper.” Source www.IMDB.com – Ransom 1996 Note the article is based on the author’s creative opinion – no ransom existed or was paid.