The Federal Reserve ended seven years of zero interest rates today but very little else changed, a verdict broadly endorsed by rallying financial markets.
That’s not only very likely just as the Fed wants it, but points to continued easy conditions, ones which may not prompt any acceleration in growth or inflation but will remain reasonably comfortable for all but the riskiest assets.
The things which haven’t changed: rates remain easy, the Fed’s balance sheet will remain huge and it will continue to have a fairly strong regard for the smooth (read: upward) progress of financial markets.
“The first thing that strikes us is that, as we have been arguing, the Fed has proved slightly more dovish than expected (emphasizing in particular the word ‘gradual’),” Simon Derrick of BNY Mellon wrote in a note to clients.
“Given the forces in play (most notably the disinflationary forces in play – from lower oil prices to a stronger dollar), this was to be expected. This, then, is starting to look like the environment we thought would emerge with a Fed that, while hawkish, is careful not to disturb the markets’ equanimity.”
Hawkish perhaps, but a hawk that had to be backed into a corner before it would pounce. Yellen explained the FOMC’s hesitation to raise rates by pointing to the fundamental asymmetry of their position with rates at zero. There is room to hike, but not, with conventional tools, to cut.
That dynamic, that the Fed must fight shy of market upsets because it lacks ready tools, has not changed now that they have 25bp which conceivably could be cut.
“The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run,” the Fed said in its statement.
Forecasts by the Fed of the future path of rates still imply a fairly steady upward progress: 100bp of hikes next year and another 100 the year after. That’s not how the market sees it, nor is it consistent with noises Yellen was making at her post-decision press conference, where she emphasized that she “strongly doubts” the likelihood of evenly spaced, “mechanical” rate rises.
Old age doesn’t kill, but it doesn’t help
That in part is simply another attempt to emphasize that the Fed will react to events as they unfold, rather than follow some script back to normality.
That’s perhaps a good thing, because a world where 2017 base rates are 250bp is one with a 10-year Treasury note yield another 2 percentage points or so above that. Good luck with those corporate bond payments if so. The pity would be that corporate America would shift from under-investing so that it may borrow money and buy back shares to under-investing in order to pay the money back.
In many respects the Yellen of the press conference was a woman fighting against the steady progress of the clock, arguing instead that this economic expansion, now in its 77th month, has further to run.
“I feel confident about the fundamentals driving the US economy,” Yellen said. “It’s a myth that expansions die of old age.”
They die, usually, of the cumulative damage of the excesses that develop as they age. In our circumstance that may be both good and bad news. Good, in that while there are areas of financial excess, there are precious few signs of widespread consumer over-confidence. Consider the windfall which consumers have had from dropping energy prices. That has not translated into particularly strong consumer spending, and outside of the auto market, nor has it led to too much more household leverage. The personal savings rate was 5.6% in October, compared to 4.5% the same month a year earlier.
It may be that the reality of secular stagnation – slow growth with structurally low inflation and wage growth – has dawned on consumers, and is constraining them.
So, just as old age may not be killing this particular expansion, the reality of its day-to-day life may be not what you would hope.
That argues for a Fed which declines to deliver the 100bp implied in its forecasts next year, and takes great care not to upset financial markets.
A sluggish Fed for stagnant times.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
