The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates
Summary – Oops I Did It Again!
The Fed’s desire to communicate openly and transparently is running afoul. And Bernanke seems to be running afoul of the policy.
Last month, after making it clear he wanted to begin reducing bond purchases the markets sold off, particularly the interest rate markets and in a short period mortgage rates were a full point higher. Realizing they might continue to rise, he and his compatriots immediately reversed course attempting to ensure bond mavens believe QE is here to stay.
Unfortunately, the cat was already out of the bag and the increase in bond rates effectively tightened monetary policy before the Fed got a chance.
We won’t see the effects of this tightening for a few months, but the reversal of rhetoric is not helping rate levels. In fact, according to a recent CNBC poll, half of market participants expect the Fed to scale back bond purchases in September, while an additional 20 percent believe they will begin reversing course before the end of the year.
Ben tried to be transparent, but got hit over the head with higher rates.
- The Fed’s unemployment target of 6.5 percent is near. The unemployment rate has steadily marched downward from 10 percent nearly four years ago to 7.4 percent today. They have stated they are targeting a rate below 6.5 percent before considering interest rate increases, but this does not mean rate increases are guaranteed once this threshold is crossed.
- Inflation remains low, but the Fed expects some increase. By all accounts, broad measures of inflation remain well below the Fed’s 2 percent target level, depressed recently by some oddball issues with Medicare reimbursement rates. Nonetheless, the Fed could hold short-term rates steady until fears of inflation rise from here.
- Replacement talk will continue to ramp up. Janet Yellen and Larry Summers are the clear front-runners to replace Bernanke in January. Both are theoretically “qualified,” but Larry is more strongly connected to the Obama administration. His nomination could signal further loss of independence for the Fed.
- QE fine-tuning talk is a waste of breath. Should the Fed “taper” in September, pundits will shift from “whether or not” to “how much?”Does it really matter if the Fed is buying $60 billion or $85 billion of securities per month? Only if the change in pace tells you something about future interest rate moves – and that remains to be seen.
What to Look for...
Leading up to the September 17 -18 FOMC meeting, I will be reading the tea-leaves in cups left on lecterns after each member gives a speech to see if we can finally move the conversation from “whether” they will taper to “how much.” Hopefully, none of them drink coffee.
However, we must realize this conversation – like most Fed-watching - is primarily a game theory exercise with the real importance focused on the market’s interpretations of potential Fed moves. The yield curve can get much steeper from here should markets decide to move up their rate hiking forecasts.
A Picture is Worth…
Though the yield curve is steep by historical standards, it could get steeper given the Fed’s artificial anchor holding down the front end. Don’t underestimate the market’s ability to build in outsized inflation or rate increase expectations.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or SVB Asset Management, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
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