This Is the End

This is the end. The end of the accommodation. The end of easy money.

The Federal Reserve hiked interest rates last month for the 8th time, bringing the Effective Fed Funds Rate up to 2.18%, its highest level since April 2008.

Image of effective fed funds rate from July 1954 to October 2017

More importantly, the Fed Funds Rate now stands above U.S. core inflation (2.17%) for the first time in 124 months.

Effective fed funds rate image from Jan 1958 to June 2017

This brings to an end the longest period of easy money in history.

Negative real fed funds rate image from August 1958 to August 2016

Saying there’s no comparison to the current period would be a gross understatement. Historically, the Fed has initiated easy money policy only as an emergency stimulus, either during or shortly after a recession. When clear signs of expansion took hold – and an emergency measure was no longer necessary – the Fed would begin to normalize rates.

In the current cycle, this simply did not happen. The recession ended in June 2009 but the Fed held off from hiking rates until December 2015. Until last month, they were acting as if emergency measures were still necessary.

The prior record of easy money lasted just 39 months, from October 2001 to December 2004. Many believe this was one of the principle causes of the housing bubble that peaked in 2006. The easy money period that just ended exceeded that record by over 7 years.

Longest periods of easy money chart from 1958 to 2018

The questions for investors today:

(1) What excesses have been built from this extraordinary period of easy money?

(2) Will market behavior begin to change now that it is over?

As to the first question, a strong argument can be made that easy money has found a home: U.S. equity valuations are at the highest end of their historical range, housing is stretched once again in relation to incomes, and the premium from owning high yield bonds is at its lowest level since 2007.

Image of BAML high yield index from July 2007 to July 2018

As to the second question, no one really knows because we’ve never been in this situation: over 9 years into an expansion with the Fed just now moving to a neutral policy. This is the end. But what comes next is far from clear. There’s simply no precedent.


Related Posts:

Are Equity Returns Dependent on Easy Money?

Fed Hikes and Stock Market Returns



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 four award-winning research papers on market anomalies and investing. Charlie 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 and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Charlie 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 also holds the Certified Public Accountant (CPA) certificate.

In 2017, Charlie was named the StockTwits Person of the Year. He has been named by Business Insider and MarketWatch as one of the top people to follow on Twitter and his work has been featured in Barron’s, Bloomberg, and the Wall Street Journal.

You can follow Charlie on twitter here.


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