Tag Archives: interest rates

reversing quantitative easing

April 6, 2017 By in Federal Reserve, interest rates, Uncategorized Tags: , , , , , , Leave a comment

US stocks were up by about 1% yesterday when the minutes of the last Fed meeting came out.  As Fed watchers saw the topic of paring down the Fed’s $4 trillion+ holdings of government bonds was mentioned, stocks (but not bonds) began to give back their gains and ultimately finished the day lower.

What’s this about?

  1.  The Fed typically uses the Federal Funds rate for overnight loan to loosen or tighten money policy.  In doing so, it depends on the banking system to broadcast increases or declines in interest rates into the market for longer-term debt.  The problem since 2008 is that the banks had destroyed their own creditworthiness through years of unsavory and unsuccessful speculative financial markets trading.  So they were ineffective in performing this crucial rate-determining role.  Congress and the administration were–and still remain–lost in their inside-the-Beltway alternative universe, so there was no hope of help for the failing economy from that source.  The Fed’s solution was to begin “unconventional” operations, by buying huge amounts of longer-dated government debt in order to push down long-term interest rates itself.  It now holds something like $4.3 trillion worth of Treasury and government agency debt.
  2. The Fed has long since stopped making new net purchases of longer-dated bonds.  But as its existing bonds mature, it has continued to roll over the money it gets from them into new bond purchases.  The next step for the Fed in normalizing the long-term debt market will be to stop this rollover.  The consensus is that this change will happen later this year or early next.
  3. What’s “new” from yesterday is that the Fed put this thought down in writing, without specifying any details.

My take:  while the Fed announcement may have been the trigger for an intra-day selloff in stocks, the Fed minutes are not a big deal.  There is an investment issue as to how the Fed will proceed, but that will ultimately be influenced by how capable Mr. Trump will be to get Washington working again.

The President’s early performance has had two consequences:  US investors are beginning to think about shifting money to Europe.  Despite Brexit, that region is beginning to experience its own economic growth.  As well, it is having deep second thoughts about electing Trump-like figures in their own countries (we’ll learn more in the first round of the French elections on April 23rd), thereby increasing their attractiveness as an investment destination.

the Fed’s inflation target: 2% or 3%?

April 5, 2017 By in Federal Reserve, inflation, interest rates, negative interest rates, Strategy, Uncategorized Tags: , , , , Leave a comment

There seems to me to be increasing questioning recently among professional economists about whether the Fed’s official inflation target of 2% is a good thing or whether the target should be changed to, say, 3%.

The 2% number has been a canon of academic thought in macroeconomics for a long time.  But the practical issue has become whether 2% inflation and zero are meaningfully different.  Critics of 2% point out that governments around the world haven’t been able to stabilize inflation at that level.  Rather, inflation seems to want to dive either to zero or into the minus column once it gets down that low, with all the macro problems that entails.  It’s also proving exceptionally hard to get the needle moving in the upward direction from t sub-2% starting point.  My sense is that the 3% view is gaining significant momentum because of current central bank struggles.

This is not the totally wonkish topic it sounds like at first.  A 2% inflation target or 3% actually makes a lot of difference for us as stock market investors:

–If the target is 3%, Fed interest rate hikes will happen more slowly than Wall Street is now expecting.

–At the same time, the end point for normalization of rates–having cash instruments provide at least protection from inflation–is 100 basis points higher, which would be another minus for bonds (other than inflation-adjusted ones) during the normalization process.

–Over long periods of time, stocks have tended to deliver annual returns of inflation + 6%.  If inflation is 2%, nominal returns are 8% yearly; at 3% inflation, returns are 9%.  In the first case, your money doubles in 9 years, in the second, 8 years.  This doesn’t sound like much, either, although over three decades the higher rate of compounding produces a third more nominal dollars.

Yes, the real returns are the same.

But the point is that the pain of holding fixed income instruments that have negative real yields is greater with even modestly higher inflation than with lower.  So in a 3% inflation world, investors will likely be more prone to favor equities over bonds than in a 2% one.

–Inflation is a rise in prices in general.  In a 3% world, there’s more room for differentiation between winners and losers.  That’s good for you and me as stock pickers.

 

a steadily rising Fed Funds rate into 2019

January 19, 2017 By in fed funds rate, Uncategorized Tags: , , , , Leave a comment

That’s the thrust of Fed Chair Janet Yellen’s remarks yesterday about rates in the US.

She said that there would be “a few” increases in the Fed Funds rate in each of 2017 and 2018.  Assuming that a few = three and that each increase will be 0.25%, Yellen’s statement implies that the rate will rise steadily until it reaches 2.0% sometime next year.

In one sense, two years of rising interest rates sounds like a lot–I know that’s what I thought the first time I was facing this prospect as a portfolio manager.  But if the neutral target rate for overnight money is the level that achieves inflation protection but no real return, 2% should be the target.  If anything, it’s a bare minimum.

In my view, two surprises to the Yellen forecast are possible:

–if President Trump is able to launch a significant fiscal stimulus program, the rate rise timetable will likely be accelerated, and

–if the inflation rate rises above 2%, which I think is a good possibility, then the Fed Funds rate may need to rise above 2% (2.5%?) to keep inflation in check.

Typically, a time of rising rates is one in which stocks–buoyed by increasing corporate earnings–go sideways, while bonds go down.  In the present case, earnings growth will likely depend on an end to dysfunction in Washington.

 

 

Employment Situation, December 2016

January 6, 2017 By in employment, Employment Situation report, Uncategorized Tags: , , , , , 1 Comment

The Bureau of Labor Statistics of the Labor Department issued its monthly Employment Situation  this morning at 8:30 est.

According to the release, the economy gained 156,000 new jobs in December, more than enough to absorb new entrants into the workforce.  Revisions to October figures were -7,000 jobs, to November’s, +26,000, meaning the net revision to the prior two months’ data was +19,000 new positions.

While this is a so-so result, we should consider how much may be due to random statistical variations in the data and, more importantly, how much comes from the difficulty employers are apparently having in finding qualified candidates who are currently unemployed.

More evidence that the latter is becoming a more significant issue comes from the rising trend in average hourly wages the BLS is also reporting.  for the 12 months ending in December, wages have been increasing at an inflation-beating 2.9% rate.  If we, methodologically incorrectly, take the December wage gains alone, the year on year increase is 4.6%.

The bottom line:  good news, and evidence the Fed will likely take as prompting it to raise the Fed Funds rate again sooner rather than later.

Shaping a Portfolio for 2017: interest rates and currency

December 30, 2016 By in Shaping a Portfolio for 2017, Shaping a Portfolio for 2017: interest rates and currency, Strategy, Uncategorized Tags: , , , , Leave a comment

To a great degree, changes in interest rates and changes in currency substitute for each other in an overall macroeconomic sense.  A rise in the world value of the US$ is equivalent to an increase in interest rates, in that both act to slow down overall US growth.  A decline in rates or in the dollar acts as stimulus.

What is 2017 likely to bring?

interest rates

Ignoring the mid-year lows, one-month T-bills began 2016 at a 0.17% yield and are now at 0.39%.  The 10-year bond opened the year yielding 2.24% and is closing at 2.46%.  Over the same period, the Federal Reserve has raised the overnight money rate by 0.25%.

My guess is that the Fed will raise the overnight lending rate by at least 0.50% and possibly by 0.75% in 2017.  The latter would likely translate into a rise in the 10-year to something just below 3%, the former to a yield of 2.75% or so.

currency

I think the chances of the larger rate rise are greater if the dollar remains around today’s level.  As I’ve written recently, I think the US stock market is already trading as if long-dated Treasury bonds were yielding 4%–where I think the endpoint of restoring rates to normal will be.  That’s something that probably won’t occur until 2018.

In addition, the US stock market has typically gone sideways during past times of Fed tightening.  What would be unusual this time around would be if Congress follows through on a large, growth-stimulating, public works spending program.  This would, I think, minimize any negative effect rising rates would have on stocks.

effects on the S&P 500

If the past is prologue, the main effect of rising rates and rising currency will be on the relative performance of sectors.

The more interest rates rise, the more attractive bonds will become vs.stocks whose main appeal is their stream of dividend income.  So income stocks would be negatively affected.

The more the US$ rises, the weaker the US$ growth of foreign operations of US multinationals will be.  Import-competing businesses would be hurt as well.  Purely domestic firms would be relatively unaffected.  My guess, however, is that the bulk of the dollar rise on a more functional national government has already occurred.