Merry Fedmas!
All the talking and conjecture may finally be coming to an end. Are we about to finally say good-bye to the multiple Quantitative Easings and the multi-year Zero Interest Rate Policy of Fed these past almost seven years? Those moves were intended to stabilize the global financial system and to promote our economic growth.
As of 11am, PST, this Wednesday, the day that many have thought would never come, the financial world shall have effectively stopped, waiting for the pronouncement from Fed Chair Janet Yellen as to what she and the other members of the Federal Open Market Committee (FOMC) have decided to do about the Federal Funds rate.
The Fed Funds rate is the rate at which banks loan money to each other overnight; about as short-term as you can get. It’s from this rate that most other US interest rates are determined.
While seemingly an innocuous number, the guessing about when and by how much the Fed would raise the rate is, I believe, one of the reasons why we’ve had an effectively unchanged market so far this year. Traders can’t deal with uncertainty so they haven’t gone too far in any direction in making trades.
As this is written, CME Group traders are pricing in an 83 percent chance of a rate hike by one-fourth of one percent, 0.25%. If it weren’t for all the headlines, would you have even noticed – or cared – that the rate that banks charge each other to borrow money from one another would be up by a quarter-point?
So the talk has moved on from “if” rates will rise to what will happen when they do go up. The uncertainty around that is the basis of much of the market’s fluctuations; trading based on fears that something bad “might happen.”
A recent Wall Street Journal story written by John Hilsenrath said many economists – presumably from this same group – believe the Fed will lift rates now…only to cut them back to zero in the future.
Further, in a prime example of recency bias, it’s been my observation that many analysts, journalists, money managers and policy-makers have decided that this raising of rates will conjure up the ghost of 2008. This same group has also been functioning for seven years under the misguided belief that all the economic growth and rising stock prices we’ve had since 2009 have been a “sugar high;” enabled only by the Fed’s easy money policy.
Sure, the Fed has bought a lot of bonds. However, as Brian Wesbury, chief economist at First Trust notes, the banks have held, and still hold, a vast majority of that money in excess reserves. You can see it on the Fed’s balance sheet. If that money had been in circulation, we would have had the runaway inflation the above group was touting.
Fed has two jobs
The Fed’s so-called “dual mandate” is to help ensure solid job growth and stable prices. While previous tightening cycles were instituted to help squash the high inflation of the 1970s or contain the “irrational exuberance” of the late 1990s, this pending series of hikes follows improving conditions.
Regarding the job growth, I believe the consistent recovery of the job market since 2009 offers the most obvious sign that it’s time to boost short-term rates from the ZIRP levels. There are six measures of unemployment – including the “headline” rate of five percent. All have fallen to levels at, or close to, pre-recession levels. The rate of layoffs has fallen and job openings are well above levels seen before the Fed began flooding the economy and financial system with cheap money to boost that hiring.
As to price stability, aka, inflation, based on the majority of regular economic reports we get, our economy has returned to a steady, though slower than normal, growth rate. While inflation remains below the Fed’s 2 percent annual growth target, it’s hardly gone away.
One measure tracked by the Dallas Fed tries to smooth out some of the price volatility using a “trimmed” index that eliminates extreme data points on the high and low end. By that measure, inflation is running at an annual rate of about 1.7 percent…close enough for government work.
Conclusion
To be sure, the economy – both here and abroad – faces a series of headwinds – so what else is new? For instance, Oil prices are down because of new supply, not a potential set of rate hikes sometime in the future.
Nonetheless, it’s my strongly held belief that the effect of a one-quarter percent increase in the Fed Funds rate will likely cause barely a ripple in our economy… about as much market and economic impact as the much-feared (and media induced) Y2K panic.
Some believe there’s a connection between the recent challenges regarding some high yield bond funds and the Fed’s pending action. I don’t think so.
The problems of the funds in the news have little to nothing to do with the Fed. The issue is more about concerns regarding the viability of the lower credit rated companies that make up the high yield market, the over-concentration by many of the relatively small funds in a very few issues to improve yield and the commodity price weakness underlying some of the energy related issuers of the bonds. High yield bonds are more dependent on the viability of their issuers and to a lesser extent longer-term bond rates – definitely not the short-term rates the Fed is in charge of.
What all the data points are likely to add up to is the Fed providing what many term a “dovish hike.” This is why all will be listening carefully to Miz Y’s pronouncement. Her phrasing indicating an increase that the Fed will move carefully in 2016 will likely be well received by the traders.
If – and when – the Fed raises interest rates, it would be with the thinking that our economy is strengthening. Growth has been, and will likely be, powered by new technology, not Fed policy. Tech developments such as the 3D printing of body parts, biotech advances, along with the always improving methods to improve the extraction of crude. Who knows what the iPhone 57 will be able to do…
Take a deep breath. Let’s see what the Fed does and let things settle in. Hopefully, everything is going to be just fine. You heard it here first.
Cheers!
Mike
Securities and Investment Advisory Services offered through KMS Financial Services, Inc.
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