Tag Archives: Federal Reserve

Fed board members speak

March 6, 2014 By in Current Market Thoughts, economics Tags: , , , , , , , Leave a comment

Over the past couple of days, Richard Fisher, President of the Federal Reserve Bank of Dallas, and Charles Plosser, President of the Federal Reserve Bank of Philadelphia, have made public comments about the state of the economy and about money policy.  I think these are early indications of the Janet Yellen style of communication, which would seem to me to be considerably more blunt than her predecessor’s.  The main points, as I see them:

1.  weather aside, the US economy is now operating at very close to its maximum sustainable rate of somewhere in the 2.0% – 2.5% real annual growth range

2.  money policy is too loose at the moment.  Excess money is flowing into speculative financial activity, evidenced by unusually high prices for the most risky stocks and bonds.  In other words, tapering will continue apace.

3.  the Fed is focusing on the next step in removing emergency stimulus–that is, raising interest rates.  That step is not as far in the future as financial markets appear to think

4.  economic growth in the US is being held back by inappropriate fiscal policy.  Congress and the administration have wasted the opportunity presented by five years of low interest rates to make obvious policy improvements, like revamping the tax code, that would make growth stronger.  Washington’s behavior isn’t too different from what has been happening in the rest of the developed world.

5.  withdrawal of unconventional monetary stimulus may have unforeseen negative consequences, since this is the first time QE has been done.  The implication is, I think, that a little less dysfunction in Washington might help the process along.

In short, the Fed is in tightening mode.  And, interestingly, it is trying to shift the spotlight onto the administration and Congress as the only possible source of further economic growth.

the Larry Summers market rally

September 16, 2013 By in Current Market Thoughts Tags: , , , , , 1 Comment

Summers withdraws

Yesterday evening, Lawrence Summers, President Obama’s choice to replace Ben Bernanke as Chairman of the Federal Reserve, announced he was withdrawing his name from consideration.

Global stocks and US bonds jumped on the news.  The dollar declined slightly, as well.

why the celebration?

The consensus view on Wall Street is that Mr. Summers would have begun to raise interest rates in the US much more aggressively than had been the Bernanke policy.  It isn’t clear that Mr. Summers’ view is wrong.  After all, the Fed is justifying its current super-accommodative stance by pointing to its mandate to fight unemployment , not the more typical central bank responsibilities to keep the economy on an even keel.

But Mr. Summers is also somewhat of a loose cannon.

For example, he was removed as president of Harvard after alienating the tenured faculty by his brusque management style.  He’s also suggested that the paucity of women scientists in the US may be due to genetic deficiencies in the female brain.  As well, in an article titles “How Harvard Lost Russia,” the Institutional Investor questions Mr. Summers’ defense of a protege, Andrei Schleifer, who was convicted of conspiracy to defraud the US for violating conflict of interest rules while working as a government adviser in Russia.

why the withdrawal?

Mr. Summers’ withdrawal comes after a series of prominent Senate Democrats publicly announced they would not vote in his favor.  The one who caught my eye is Elizabeth Warren of Massachusetts, who was a professor at Harvard while Summers was president.

who will the new nominee be?  

It’s hard to say.  The gracelessness with which Mr. Obama terminated Ben Bernanke a few months ago suggests there’s a big personal eqo issue involved.  Janet Yellen, the number two person at the Fed, and the “easy” choice, was never Mr. Obama’s favorite–maybe because she was an adviser to the Clintons.  I guess it’s possible that choosing Summers was less about him than about Ms. Yellen.

Since Mr. Summers’ abrasive personality and peculiar social views are as much a pert of his rejection as his economics, it could be that a new nominee will also hold Summers’ more aggressive interest rate views.

In any event, I think the present market advance is a one-day affair, that may well be reversed when a new Fed nominee more acceptable to the Senate surfaces.

 

 

shifting Federal Reserve priorities

June 19, 2013 By in Current Market Thoughts, economics Tags: , , , , , , , , , Leave a comment

long-term unemployed

For some time the Fed has made it clear that its number one priority has been the economic well-being of the millions of workers laid off during the Great Recession who have yet to find work again.  The Fed’s worry is that the longer this group stays unemployed the greater the chances it will morph into a permanent underclass of the type Europe has long had.

Recently, the Fed has been increasingly vocal about the fact that monetary policy can do little for these incipient lost economic souls.  Their rescue is really a job for fiscal policy that promotes job creation–say, reform of the tax code or infrastructure spending–sound advice that is falling on deaf Congressional and White House ears.

shifting gears

The Fed’s priorities appear to be changing, however.  It’s primary focus is shifting to preparing financial markets for a long journey away from today’s emergency-low interest rates to more normal (that is, higher) ones.  The agency is doing this in its usual indirect way.  It has been so long since investors have had to contemplate a higher cost of money, however, that many may not understand the ritual dance that is now beginning.

Fed signals

So far, the signaling has included:

–remarks by outgoing Fed Chairman, Ben Bernanke,

–discussion by other ranking Fed officials,

–mention in Fed meeting notes,

–hints dropped to favored reporters and columnists.  Their identities as conduits for Fed information are well-known to Fed watchers, who immediately understand the true source of the reporters’ statements.

its purpose

The idea is to get the markets to start to move by themselves in the direction the Fed wants.  That way Fed interest rate hikes seem to be only validating positions the markets are already taking, something the Fed prefers.

Two factors make this process more daunting than usual:

–bond investors have been conditioned for over three decades to think that interest rates only go down,

–in the Fed’s view, overnight money has to rise by more that 400 basis points to get back to “normal,” a huge move that will likely take place over several years.

The real trick will be to prevent bond market from rushing ahead and making the entire move in one leap once investors figure out what’s going on.  It seems to me that this is the purpose of the apparent Fed “confusion.”  It’s deliberate–and it’s intention is to get the interest rate train rolling without gathering too much of a head of steam.

US bond market environment, October 2012

October 18, 2012 By in Bond Environment, Current Market Thoughts, securities markets, Strategy Tags: , , , , , , , , , , , Leave a comment

This is the quarterly letter sent by Strategy Asset Managers, LLC, a bond management firm, posted with permission from my friend and mentor, Denis Jamison.

Today’s post sketches out the current situation.  Tomorrow’s wil give Mr. Jamison’s investment conclusions.

a market of bonds

It’s an old saying on Wall Street–this isn’t a stock market but a market of stocks.  In other words, individual stocks can rise or fall regardless of the general direction of the market.  The same can now be said of the fixed income market.  formerly, the direction of interest rates dictated returns across most segments of the bond market.  If Treasuries called the tune and the rest of the fixed income market danced along–some a little slower or faster–but they were all moving to the same beat.

That’s now changed.

Policies implemented by the federal Reserve effectively have eliminated real yields for “riskless” securities like US Treasury bonds.  (By riskless, I mean credit risk–that is, the risk of not getting paid at maturity.  T-Bonds still have plenty of market risk.)  Without government bond yields calling the tune, all sorts of other factors are determining returns in various segments of the fixed income market.

The markets are now being driven by monetary policy designed to:

(1)  keep interest rates at zero for short-term, low-risk investment-like savings accounts and US Treasury bills and notes,

(2)  narrow the yield spread between “safe” investments like US Treasuries ans riskier investments like corporate bonds, and

(3) lower the return spread between fixed income assets and securities with no maturity–like common stocks.

In fact, the Federal Reserve would really like investors to go out and spend their money on real goods and services.  It has stated that zero interest rates are here to stay until the economy has fully recovered–that means much lower unemployment and much stronger economic growth.  Chairman Bernanke, unfortunately, doesn’t have a crystal ball and isn’t telling us when he thinks that will happen.  At the moment, however, he plans no change in interest rate policy through 2014.  Of course, he has pushed out the probable end date of his quantitative easing program before and is likely to do it again.  Market pundits have started referring to the Federal Reserve’s monetary policy as QE unlimited.

When the bank is playing…

…you just keep dancing.  We have just entered the third phase of the Federal Reserve quantitative easing.  in the wake of the 2008 financial collapse.  Essentially, “quantitative easing” means that the Federal Reserve will buy financial assets from banks and put cash in their–the bankers’–hands.  The hope is that, somehow, this money will filter through the system and the banks will loan that money to you and you will buy a house or a car or anything.

Why doesn’t the Federal Reserve just lower interest rates and make the loans cheaper?  Well, interest rates are already at zero so they need to do something else.  Since the banks are stuffed with money, will they loan the money to you?  No, because you don’t have a stellar credit history and your house is under water.  They refuse to take credit risk because they face political and regulatory retribution if they suffer any losses.

Has the quantitative easing program improved the economy?  Not yet, but it has certainly been a windfall for the financial markets.  The S&P market index is up 115% off the 2009 lows and every time it seems to be losing steam, we get another QE program.

Is all this going to end badly?  Probably, yes, but in the meantime don’t fight the Fed, don’t fight the tape and keep dancing.

The quantitative easing programs are having one clear impact–a massive increase in the Federal Reserve’s balance sheet.  The Federal Reserve was created in 1913 through a bill sponsored by two legislators, Carter Glass and Parker Willis.  Mr. Glass later went on to co-sponsor a bill that prohibited commercial banks from being securities firms.  (Interestingly, that 1933 piece of legislation was struck down during the Clinton administration.  Some say the repeal was a root cause of the 2008-2009 financial collapse.) The Federal reserve’s mandate was to provide liquidity to the banking system in times of crisis and to gradually expand the money supply to support non-inflationary economic growth.

Until 2008, the Federal Reserve provided that liquidity to the banking system by gradually expanding its assets through the purchase of government bonds from the banks.  That has changed.  Federal Reserve assets grew from $890 billion in June 2008 to $2.8 trillion most recently.  This is the result of asset purchases made by the Federal Reserve through its various QE programs.  Government bonds account for $1.6 trillion of those assets.  Another $800 billion are mortgage-backed securities and the Fed plans to add about $60 billion a month to that pile.  Unfortunately, the Federal Reserve’s capital base hasn’t kept up with the asset growth.  Now, $55 billion in capital supports those $2.8 trillion in assets–a leverage ratio of 50:1!

So, the Federal Reserve has done an excellent job of reducing leverage in the banking system through the purchase of all those assets and, as an additional benefit, helped keep government borrowing costs low.  But it has transferred a large portion of private sector bank leverage to its own balance sheet.  Any percentage change in the price of the assets on its balance sheet will be reflected fifty-fold as percentage change in the Fed’s capital.

In the movie”It’s a Wonderful Life,” the banker,George Bailey, was lucky enough to have an angel when his depositors make a run on the bank.  I hope Mr. Bernanke has an angel on his side if interest rates ever rise.

 

More tomorrow.

two more years of emergency-low interest rates!

January 31, 2012 By in Current Market Thoughts, from growth to value: the life cycle, growth vs value, Recent Market Action, Shaping a portfolio for 2012, Strategy Tags: , , , , , , , , , , Leave a comment

the January 25th Fed meeting

Last week’s meeting of the Federal Reserve’s Open Market Committee had two important results:

1.  Chairman Ben Bernanke said the Fed funds rate, which has been at effectively 0% for just over three years (since December 16, 2008–how time flies) will likely remain at or near the current low rate into 2014.

2.  The Fed gave more detail than ever before on its thinking about prospects for the US economy and the appropriate level for the Fed funds rate.

The Fed thinks:

–the long-term growth rate of the US economy is  +2.4%-2.5%  a year (vs. 3%+ a decade ago).  The agency is content, however, to allow growth at somewhat above that rate from now into 2014.

–the appropriate long-term level for the Fed funds rate is about 4.5%, which amounts to a 2.5% real rate of interest (“real” means after subtracting inflation from the nominal rate).  This contrasts with the current rate, which is a negative real rate of about 2.5%.

–although the process of normalizing interest rates will probably begin before the end of 2014, the Fed is unlikely to raise the funds rate above 1% until at least 2015.

–despite the immense monetary stimulation going on now, inflation will not be an issue.  It will remain at 2% or below.

–the “natural” rate of unemployment, that is, full employment, is 5.5% of the workforce (in theory, the 5.5% is friction in the system–like people in transit from one employment location to another, or who decide to take a short break between jobs…).

According to the Fed’s projections, the unemployment rate will remain above 8% until some time in 2013.  It probably won’t crack below 7% for at least the next three years.

implications

The forecast itself isn’t a shocker.  The Fed has been talking about slow but steady progress for the economy, with no inflation threat, for some time.  The real news is that the Fed expects the current situation to persist into 2105, a year longer than it had previously indicated.

1.  To my mind, the biggest implication of the Fed announcements is that it makes less sense than ever to be holding a lot of cash.  How much “a lot” is depends on your economic circumstances and risk preferences.  But the Fed is saying that a money market fund or bank deposit is going to yield nothing for the next two years and well under 1% for the year after that.  Yes, you have secure storage in a bank and substantial assurance you won’t make a loss, but that’s about it.

To find income in liquid assets–as opposed to illiquid ones like, say, rental real estate–you have to look to riskier investments, dividend-paying stocks or long-dated bonds.  That in itself is nothing new.  Savers have been reallocating in this direction for the past couple of years.  Last week’s Fed’s message, though, is that it’s much too early to reverse these positions.  If anything–and, again, depending on personal circumstances and preferences–investors should think about allocating more away from cash.

2.  When the process of normalizing interest rates is eventually underway, the yields on long-dated bonds and dividend paying stocks will be benchmarked–and judged–against cash yields of 4%+.  For stocks, a static dividend yield of 3% won’t look that attractive.  At some point, low payout ratios (meaning the percentage of earnings paid out in dividends) and the ability to increase cash generation will become key attributes.  Both are indicators of a company’s ability to raise dividends.

3.  It’s my experience that when the Fed begins to tighten, Wall Street always underestimates how much rates will rise.  Last week, the Fed told us that when the Fed funds rate goes up this time, its ultimate destination is 4.5%.

4.  Investors taking a top-down view, that is, looking for the strongest economies, will have to seek exposure outside the US–which will only look good vs. the EU and Japan.  The main issue is demographics–an aging population.  It’s probably worthwhile to try to figure out what characteristics of the latter two economies, both of which have older populations than the US, are due to social/cultural peculiarities and which are due to aging.  The second set of traits may well turn up in the US market as well.

5.  The mechanics of how growth stocks and value stocks work may change in a slower-growing economy.  It’s hard to know today how that will play out.  True growth stocks may be harder to come by.  Value investors who say they buy asset value of $1.00 at $.30 and sell it at $.70 may have to buy at $.20 and sell at $.60 if there’s less room for second- and third-tier companies to succeed.

I think it’s way too soon to be worrying about anything other than #1.  The rest are thoughts to be filed away for next year, maybe.