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“The seven lean, ugly cows that came up afterward are seven years, and so are the seven worthless heads of grain scorched by the east wind: They are seven years of famine.” – Genesis 41:27
If the futures market is correct, the U.S. Federal Reserve will continue to hold the Fed Funds rate at 0% for another seven months. At that point, it will be seven years of 0%, by far the longest stretch of central bank yield suppression in history. For anyone holding money in short-term checking or savings accounts (whose rates are tied to the Fed Funds rate), it has been seven lean years.
Entering the year, market participants were expecting an end of the 0% era with a rate hike in June or July. Four months later, they have shifted expectations, now predicting a hike doesn’t occur until December with many suggesting 2016 is more likely still.
Why, after six years and four months at 0%, is the Federal Reserve afraid of raising interest rates by a measly 0.25%?
A few reasons, we are told.
First, in a world of slower growth, currency wars have become the new growth engine. The U.S. Dollar’s unrelenting advance from last July through this March was a major problem for U.S. export competitiveness and corporate earnings. It was a black swan in plain sight and the Fed was certainly taking note.
Second, we have seen persistently weaker economic data this year. To say that predictions entering the year of a U.S. decoupling and 3-4% growth have missed the mark would be an understatement. The Bloomberg Economic Surprise Index has been falling since the start of the year and is now at its lowest levels since February 2009.
Third, we have seen overall inflation plummet to negative year-over-year levels, primarily due to the crash in Crude prices. Excluding food and energy, CPI over the past year of 1.8% remains below the 2% Fed “target.” The Fed wants higher inflation an believes they can achieve it by keeping rates lower for longer.
While these are all reasonable excuses to delay a hike within the ivory tower, they only make sense in the real world if you agree with one important assumption: there are no negative, unintended consequences to artificially low interest rates.
If you listen to the Fed, they will tell you this is the case, and that everything they have done is a panacea. Perhaps, but what if 0% rates are actually causing a misallocation of capital and encouraging speculation, borrowing and financial engineering over savings and investment? If so, the opposite would be true, and Fed policy could be acting as a headwind to long-term economic growth which continues at the slowest pace in history.
But what, then, is the Fed hoping to accomplish given evidence that 0% rates don’t seem to be helping to boost real economic growth?
As Jeremy Grantham wrote in his most recent letter, they are simply hoping for another asset bubble to develop and their work is not yet finished. He explains:
In the Greenspan/Bernanke/Yellen Era, the Fed historically did not stop its asset price pushing until fully-fledged bubbles had occurred, as they did in U.S. growth stocks in 2000 and in U.S. housing in 2006. Both of these were in fact stunning three-sigma events, by far the biggest equity bubble and housing bubble in U.S. history. Yellen, like both of her predecessors, has bragged about the Fed’s role in pushing up asset prices in order to get a wealth effect.
Ah, yes, the “wealth effect.” Forcing yield-starved investors to speculate in hopes that this will lead to higher consumer spending and boost the economy. Another quarter has past and we have yet to see this magical theory take hold, with real GDP growth of 0.2%. What we continue to see, though, is new all-time highs in the stock market which loves nothing more than weak economic data as it means a continuation of 0% policy.
Unfortunately, the economy is not the stock market, and pointing to stocks at all-time highs as proof that Fed policies are “working” is news to those outside of the 0.1% world.
Last November, I asked if the Fed was targeting another bubble. Six months later, the answer is clear. The median price to earnings and price to sales ratios for U.S. stocks are already at all-time highs and the Fed refuses to raise interest rates. Why? They are not yet high enough.
Years from now Janet Yellen will likely start a blog as Bernanke has done, writing that exceptionally low rates did not lead to another bubble and even if there was a bubble forming no one could identify it and it was not the Fed’s responsibility to do anything about it. She will go on to explain that the Fed was not the reason for low rates in the first place and that even if they were hypothetically responsible for artificially low rates only good came from it. She will then take on consulting jobs at the largest investment firms that benefited most from Fed policy and scoff at the notion of any quid pro quo. Rewriting history with zero accountability, as only the Fed can do.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of three award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors previously held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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