a steadily rising Fed Funds rate into 2019

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.



Janet Yellen, this week and last

Fridays are strange days on Wall Street.  That’s because, unless they’re super-confident, short-term traders don’t like to hold a large inventory of securities over a weekend.  Too much time for bad stuff to happen.  So they sell enthusiastically on Friday afternoons.

There’s certain sense to this behavior.  For them two days+ may be a long holding period.  Also, companies and people, particularly sneaky ones, like to save bad news up for late Friday afternoon or the weekend, when they think no one is paying attention.  This lessens the pain, they think.  Often, it has the opposite effect, however, since anyone who’s been around for a while knows what a late-Friday press release invariably contains.


So in one sense it’s not a great surprise that the huge effort–enough to send her staggering off the stage–Janet Yellen put out yesterday to explain that, yes, the US economy is in great shape and, yes, the Fed is going to take the first baby steps to get the country out of interest rate intensive care (IRIC (?)–although it may be too late for this acronym) before New Year’s eve had no lasting positive effect on stock prices today.

The reason is that, aside from robots designed to react to newsfeeds, everyone knew that already.  In fact, her announcement on Thursday the 15th that the Fed Funds rate would stay at zero for now wasn’t a shock, either.  Futures markets had been putting the odds of a rate hike in September at less than one in three.

Yet the stock market took something Ms. Yellen said last week the wrong way.  If it wasn’t the interest rate announcement, what was it?

Actually, I think there are two things, one said and one not.

The first, and more important, in my view, is the unspoken but strongly held belief by the nation’s finest economists that if we have to depend on the White House and Congress for economic support, we’re doomed.  That’s because monetary possibilities to plug up a hole in the bottom of the boat are all used up.  The federal arsenal now contains only fiscal policy—changes in government regulation of business, or in spending priorities or in taxes.  The Fed knows it isn’t going to get bailed out by Washington if it raises rates too soon–something that has gotten many nations into trouble in the past.  Therefore, it has to err on the side of caution, even if that’s unhealthy to do.

We all sot of know this, but it’s not a plus to be reminded that as a nation we’re stuck in at best second gear as long as Washington dysfunctions its way through life.

The second, the one said, is that developments in China have the potential to hurt US growth enough to tip us over the edge.  I don’t think the effect on the stock market is so much about the details.  It’s the headline that matters–that the US is no longer so large that we’re impervious to what may happen in any other single country.  It conjures up thoughts of the post-WWI, when the UK passed the mantle of world economic leadership to the US, except that we’re now in the role of the UK.

Again, everyone sort of knew this was happening.  But having it confirmed by our foremost economists is another thing.

To put this in stock market terms, I don’t think Ms. Yellen is calling into question the market’s ideas about current earnings as about the multiple those earnings are worth.




What Janet Yellen did/didn’t say yesterday

Yesterday the Fed announced that its Open Market Committee had decided to postpone, yet again, beginning to raise interest rates from their current intensive-care lows.

In her press conference following the decision, Jane Yellen cited several reasons :  the recent rise in the dollar, a plateauing of consumer spending in the US and worries that the authorities in China might be bungling their way through the necessary change in that economy from export-led growth to one that’s led by domestic demand.  (Ms. Yellen pointed to recent ructions in the Shanghai and Shenzhen stock markets as evidence for the last.  Personally, I don’t think this is correct.  I see those markets’ rise and fall as what almost inevitably happens when a country allows margin borrowing for the first time.)

Whatever the motivations, the fact remains that the Fed sees the current situation in the US as too risky to warrant even a miniscule rise in short-term interest rates.  …and this is despite six years of economic growth and increasing employment since the economy bottomed in 2009.

What isn’t being said here?

Two things, I think:

–after Japan’s financial collapse in 1989-90, that country twice tightened economic policy prematurely–once by raising interest rates, a second by raising taxes.  The result of these miscues was a quarter-century of deflation and economic stagnation.  The Japan example suggests that in a slow growth environment with no inflation the risks of policy tightening are much larger than most people in the US suspect.

–governments have two main tools to influence GDP growth:  monetary (changes in the price or availability of credit) and fiscal policy (changes in spending and/or taxes).  Fiscal acts slowly but lays the general foundation for growth and indicates a broad direction for expansion.  Monetary acts relatively quickly and is most useful for mid-course corrections, slowing or accelerating the pace.  A dysfunctional Washington has meant that, other than the bitterly contested bank bailout plan in 2009, fiscal policy has done virtually nothing useful to stimulate growth over the past half-decade (arguably, it’s a mild deterrent).  Nor is it likely that Congress, now winding up to shut the government down, will change its stripes.  This implies that the Fed has no backstop if it makes a policy mistake.


Nothing about either is particularly new news.  But the Fed decision calls attention the major structural difficulties the US economy faces.  This is not a recipe for having stocks go up.

Janet Yellen’s press conference yesterday

Janet Yellen, new Chair of the Federal Reserve, held a press conference yesterday, following release of the agency’s policy-setting Open Market Committee.

The committee’s decision was the expected one–to continue its program of winding down over the next six months its program of buying boatloads of federal government bonds.

During the Q&A session, a reporter asked Ms. Yellen how soon after the bond purchases end in September it might be before the Fed begins to raise short-term interest rates in the US from their current ultra-emergency low of 0%.  Her answer:  assuming the economy continues to strengthen, six months or so.  In other words, about a year from now.

This reply sent the stock market, which had been within a stone’s throw of its all-time high, into a tailspin.

From the perspective of investors like you and me, the Yellen comment is not new news.  It’s pretty tame.  In the fast-twitch world of short-term traders, however, the stock market response is understandable.  The market was likely bouncing against the top of its near-term trading range, so down was the likely short-term direction no matter what the news.  Also, this is also the first occasion when the Fed has said when short-term rates might begin to rise.  It’s a few months earlier than the consensus had expected; more important, the timing has been made (more or less) concrete. And the actual shoe dropping–no matter how widely anticipated–almost always provokes a market reaction.

The more interesting issue, to my mind, is why Ms. Yellen said what she did.  I can think of three possibilities:

–Maybe she didn’t intend to specify timing and made a rookie mistake.

–More likely, in my view, the Fed may have made a far more decisive turn toward restoring money policy to normal than the Wall Street consensus has thought.  Yesterday would have presented a good occasion for starting to get this new information disseminated.  The fact that the stock market is at/near record territory suggests it is in a good position to absorb the news; one might even ask if the Fed is worried that too much money is chasing speculative stocks.  Maybe it wouldn’t mind if stocks went down a bit.

–It’s also possible, though I think much less likely, that the Fed has come to believe that its current easy money policy is having a negative effect on the economy.  Maybe it is coming to view itself as an enabler of Washington dysfunction, that the White House and Congress have the luxury of doing nothing because money policy is so loose.


After all, what do we really know about Janet Yellen.  Well, she has a grandmotherly appearance and a vaguely unpleasant speaking voice.  That may lead one to forget that she is a woman who has risen to the top of a profession dominated by men.  This means that behind her mild-mannered exterior, she has to be super-competent and very tough.

From an investor perspective, I think the takeaway from the press conference is that monetary policy normalization is no longer an amorphous thing somewhere out in the future, but is rather an important fact of life that must be factored into any investment decision.  We also have to begin to figure out whether or not a latter-day Margaret Thatcher is emerging as head of the Fed, and what this would mean for stocks.

Janet Yellen and popping speculative bubbles

During her Senate confirmation hearing, Janet Yellen, the soon-to-be Fed chief, was asked what action she would take if she saw a speculative bubble forming in financial markets.  Would she, like her predecessor Alan Greenspan, simply watch it grow, while presumably making ready to pick up the pieces after it popped?  …or would she act–presumably by raising interest rates–to nip it in the bud?

She said she would do the latter.  She added that at present she sees no bubbles on the financial horizon.

I’m not sure what this means.

It could just be that she’s saying she doesn’t believe in the theory of “rational expectations.” a simplifying assumption of academic economists that people are cold, calculating, wealth-maximizing automatons all of the time.  This is also a premise of most academic research in finance, despite centuries’ worth of overwhelming evidence that real people seldom act that way.

Or it could be that she’s making a stronger statement  …that if she’d been in charge, she would have raised interest rates to pop the Internet bubble of 1998-99  …and that she’d have done the same to pop the housing bubble of 2006-07, as well.

At the moment, I think her’s is a statement without much content.  Millions of Americans laid off in the Great Recession are still out of work.  The economy is scarcely overheating (although I think what we’re seeing now is as good as it will get).  And government policy in Washington is retarding economic expansion, not helping it along.  So it’s hard to see where the impetus for higher interest rates would come from–which is what the Fed is communicating by saying it will leave short-term interest rates at the current zero for at least the next two years.  Also, the Fed can’t get more accommodative than it is now.

Still, I think the Yellen statement is one to keep filed away for future reference.  It implies that when we eventually get out of the mess we’re in–and assuming Ms. Yellen is still around–that the financial markets will be on a shorter leash than during the professional lives of just about everybody working on Wall Street.  Chances are what she does will take Wall Street completely by surprise.