I hope everyone’s summer was fun and an enjoyable break.
This summer, unlike the recent past, did not bring a decline in the markets. The old proverb, “Sell in May and go away” was not the right call this year.
For the most part, the markets managed to grind higher. The events that were supposed to pull the markets down over the summer like Brexit and the Fed, turned out, so far, to be benign.
The specter of a Fed Funds rate increase lurks around the markets
Having said that, the specter of a Fed Funds rate increase lurks around the markets. Many worry that the only reason for the 2009-present stock market rally (and bonds too) is the artificially low level of interest rates that the world’s central banks created.
The Fed raised rates 1/4 of a point in December 2015 and the market had a tough 1st quarter of 2016. Yet, it rebounded to new highs. All else being constant, higher interest rates reduce the values of equities, bonds, real estate, and commodities. Given that the current levels of rates are so low, it might take several rate increases to impact asset prices.
The Bears may be relying on direction and ignoring magnitude when they are formulating their predictions. It doesn’t seem that the recent economic reports merit the Fed taking action at their September 20-21 meeting. There has been a tradition but not a fast rule that the Fed will not act immediately ahead of an election.
If the economic data remains steady and the election tradition holds, the Fed would wait until the December 13-14 meeting to move rates upward.
It’s my opinion that in a tie, the Fed will hold pat on rates. While the Fed has met its employment target, it has not met its inflation target. Furthermore, the economy is certainly not in “high gear”.
Unless the latter two elements get closer to the Fed’s goals, I think the Fed would rather wait. The concern with waiting is that asset prices may well move higher. We could then end up with bubbles as we did in 2000 with internet stocks or in 2007 with housing.
The concern with moving too quickly and too much is that the Fed Governors could push the economy into the very recession they are trying to avoid.
Rock-bottom interest rates cannot create a sustainable economic recovery
With a third of global government bonds, about $10 trillion, yielding a negative rate, the world is definitely in a strange place. I think (and hope) that policymakers are realizing that rock-bottom interest rates cannot create a sustainable economic recovery.
Personally, I think regular people interpret negative rates with fear. Investors are afraid that their investments will not return enough to give them the pile of money they want or need to retire.
In this situation, people cut back and save more in an attempt to keep their piles growing. This is Keynes’ popularized “paradox of thrift”. One person saving is noble, however, a whole economy saving leads to reduced spending and low economic growth.
Tools beyond monetary policy seem to be needed but tax reform, government spending and the like require political will which is, itself, in short supply.
— Ian Green, Pendragon Capital Management
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Note: This blog article is intended for general informational purposes only. Nothing in it should be construed as, and may not be used in connection with, an offer to sell, or a solicitation of an offer to buy or hold, an interest in any security or investment product.