Mr. Zero Interest Rate Policy
“If the Fed doesn’t raise rates, that’s bad for the long bond because the bond wants it to tighten. And it’s positive for stocks because stocks love their friend, Mr. Zero interest rate policy.” – Jeff Gundlach on CBNC
Stocks indeed love their little friend, Mr. Zero interest rate policy. He has been the one constant over the past six years, providing unconditional support in good times and bad.
But a strange thing has happened over the past six months even as we learned Mr. Zero would be hanging around for longer than expected.
Stocks have gone nowhere.
Why the inability to push higher in spite of continued global easing and a more dovish Fed?
Two consecutive quarters of negative earnings growth, declining revenues over the past year, and negative GDP growth in the first quarter may have all played a part. Market participants may also be leery about further multiple expansion when the median U.S. stock is already trading at its highest price to earnings ratio in history.
All possible explanations, but perhaps another factor is at play here. Perhaps market participants have become too dovish and complacent in their expectations for no rate hike until December. If we look at the recent price action in bonds, gold, and emerging markets, all are suggesting a more imminent rate hike could occur.
The next FOMC meeting takes place in less than two weeks, on the 17th of June. My suspicion is that the Fed will take a more hawkish tone than markets are currently expecting, and move the market closer to July or September.
For if they do not, they risk losing credibility in what was supposed to be a “data-dependent” process in determining the timing of the first hike.
To wit: continuing jobless claims are at their lowest level since 2000 and the Fed has yet to move even 25 basis points (0.25%). To justify maintaining rates at crisis levels of 0% is becoming increasingly difficult. Intellectually, why should interest rates be the same today as they were in December of 2008?
Payrolls have expanded for 56 consecutive months, the longest stretch in history. The Fed Funds Rate, at 0%, is at the same level today as when the streak began. Does that make any sense unless your primary goal is to inflate markets?
By not moving until 2016 as the IMF’s Christine Lagarde is advising, the Fed risks falling behind the curve, encouraging further risk taking and misallocations of capital.
Real wage growth at 1.96% is already significantly higher than 1994 (0.11%) and 2004 (-0.88%), the last two times the Fed started hiking rates after a recession.
The Unemployment Rate, at 5.5%, is also lower than 1994 (6.6%) and 2004 (5.6%) levels.
Still, most market participants say the Fed will not move as they are not yet willing to risk popping the asset price bubbles their policies have created. We’ll soon find out.
The June meeting will feature an update to the Fed’s dot plot expectations for the future direction of interest rates. Confirming the market’s dovish expectations would require moving their projections further out in time once more, as they back in March.
Mr. Zero: From Stability to Instability
Mr. Zero interest rate policy has been the market’s best friend and a source of calm for over six years now. Naturally, the equity market has become increasingly dependent on maintaining this relationship which is neither healthy nor sustainable.
What has been a source of stability in markets (easy Fed policy) has increasingly become a source of instability as market participants have become obsessed with the timing of a more hawkish policy stance. This places the market in a more vulnerable position because any sign of an end to the 0% regime is likely to be met with higher volatility.
Thus far this increased volatility has only manifested itself in bonds, commodities, currencies and Emerging Markets with U.S. equities maintaining the status quo of tranquility. But the Dow and the S&P are not the money market; these are not risk-free securities. If Mr. Zero goes, so goes the illusion of stability.
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, CMT
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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