the June Fed meeting and “normal” interest rates

The other day, I wrote that the SEC is considering allowing mutual fund companies to place (presumably, large) exit fees on corporate bond funds, in hopes of stemming redemptions when interest rates begin to rise.

the Fed’s plans

This raises anew the issue of when the Fed will start to move the price of overnight money above the current zero, how fast will it move, and what level of rates it perceives its endpoint will be.

Wall Street perception…

What makes this important is that financial markets have come full circle over the past half-decade.  Initially, they didn’t understand the severity of the economic damage that occurred in 2008-09 and lambasted the Fed for lowering rates in a way they asserted would quickly lead to runaway inflation.  Hard to believe   …but that’s what pundits, especially hedge fund managers, were bellowing back then.

…has turned 180º

Today, however, the markets are clearly, though more quietly, expressing their disbelief in the economic and interest rate projections that the Fed had been publishing before yesterday.

before yesterday’s announcements

Before the just-completed Fed meeting and announcements, the agency’s official stance was that the normal or neutral rate for Fed Funds was 4.0%.  It also had been saying it thought the central tendency for US annual growth in real GDP to be close to 2.5%.  And it expected trend inflation to be 2%.  Add another 100bp in yield to overnight money to get the 10-year yield, and that comes in at 5%, or about double the current level.

Why the skepticism?  The main reason is that so far the US has struggled to produce a strong economic pulse, even after five years in intensive care.  Part of this is the extent of the damage done in the financial meltdown, but part is also demographics and past is that there’s little chance that Washington will make things any easier.  So, Wall Street argues, there’s no reason for interest rates to be so high.

There’s more.  Bond yields in the EU are much lower, for comparable quality, than in the US, because of the miserable shape Europe is in.  No relief in sight, as well.   As a result, European investors will find “high” US yields attractive.  This buying should temper the domestic urge to have yields rise.

In addition, China continues to generate trade surpluses with the rest of the world.  Those funds ultimately find their way into US or EU bond markets, keeping yields lower than they otherwise would be.

…and after

The Fed issues new projections yesterday.  The changes that caught my eye are:

–neutral Fed Funds rate at 3.75%, and

–trend growth in the US closer to 2.0% than 2.5%.

The Fed is edging closer to the view being expressed by the markets.  One exception:  the Fed is now signalling that the initial move up in the Fed Funds rate next year could be a bit more rapid than it had previously been planning.


Historically, the Fed’s post-emergency moves to raise rates back to normal have been bad for bonds and neutral for stocks (yes, higher rates are a negative for stocks, ass well as bonds, but rising corporate profits act as an offset).  The biggest worry about the current situation is that the required rate rise may be much larger than normal.  I suspect this may not be the Fed’s final ratcheting down of the size of its projected upward rate move.  If so, I think we can be more confident that past experience is applicable.

A lower trend growth rate for the US economy implies that growth will be harder to come by.  If so, companies that can grow their earnings quickly should acquire a scarcity premium; their stocks may well trade at higher than normal multiples.  I see strong growth coming in four areas:

–emerging markets

–companies with unique products/services

–firms serving needs of Millennials, and

–firms in mature fields building market share through acquisition.




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