I could almost feel the excited anticipation of the news channels and their sages emanating from the four screens that surround the EverBank Global Markets trading desk. As was evidenced by the countdown clocks steadily ticking off time at the bottom of our screens, networks were hoping against hope that this announcement would be their next big story. Guests appeared increasingly agitated as the time grew close – their long-debated (and oftentimes conflicting) predictions at risk until the news was revealed.
And then it was over. Just like that...
The Fed Funds target rate range will remain unchanged until further notice. Just hold the course. Chairman Yellen says, “We’ll see.”
The news channels and sages were visibly disappointed. I imagine copywriters pounding the desk next to their keyboards frustrated that after 6+ years of writing about Zero Interest Rate Policy (ZIRP) all they had to write about now was – well, ZIRP.
The market took some time to settle into the announcement as more information was revealed. Prices ran up and down reflecting the most recent parsing of the words in the release, and continued to do so with each additional comment in the press conference. The invisible hand was less mysterious that particular afternoon.
As we have discussed before, there are two sources of information about economic activity:
- First are the explicit statements made by officials like Chairman Yellen along with the economic statistics that are released by the various agencies. Like the Kremlin watchers of old, commentators diagram the sentences of Federal Reserve leaders seeking to divine the real meaning. Government statistics provide a snapshot of sorts, with large amounts of measurement precision issues.
- Second, and most important are the messages market prices leave like breadcrumbs for us to follow. People can talk, but prices reflect the net opinion at any given point in time of everyone who is participating in each individual market.
Now that the Fed has spoken, what tale is the market telling us today?
Chairman Yellen noted that the statistics seemed to indicate reasonable growth in the US economy. But she joined other commentators in saying that some real uncertainties exist in other markets, such as we’ve seen in Asia that cause concern. The most recent stumbles in the global marketplace, led by China, scared us all and it appears our Chairman was right there with us.
Watching the new lead news story – the European refugee crisis – I wonder if this won’t have a much bigger impact than might be discounted in the markets already. Absorbing that many individuals into an economy that isn’t exactly setting new records for growth seems like a significant distraction.
This message of low growth is reflected loud and clear by the stock markets. In the US, the major indexes are down a few percent on the year for the first time in six-years leaving investors perplexed about how to evaluate their next move.
Very Low Inflation
Hanging out there for all of us to see if we care to look, and I do, is the yield on the 10-Year US Treasury Note: 2.13% as I write. Holders of Treasury Notes are giving up the use of their money for the ten-year period. Over that time they expect the yield paid on top of inflation to cover risk of changes in the market, plus a premium to put in their pocket for their troubles. Over time, many commentators suggest that these requirements would total about 1.60% above inflation.
Doing the simple math on that would suggest that holders of these notes expect an average inflation rate of 0.53% over the next ten years - which is around half of one percent. Perceptive readers will note that this is a long way from the stated Fed target rate of 2.00%, which was again mentioned in Chairman Yellen’s announcement. Given that the market thinks that inflation will remain below the Fed target rate of 2% on average for ten years that suggests to me that the Fed will likely feel it needs to maintain 1) it's Quantitative Easing program and 2) stay close to the ZIRP that has been the focus of this current debate.
US & Europe Growing In Parallel
If Europe is stumbling, and a line of commentary says that they are, then the value of the euro should be falling significantly. But right now the market isn’t buying that theory. Since dropping into the couloir at the top of a black diamond run in April 2014, the euro declined 25% from around 1.40 in April 2014 ending the run at about 1.05 USD per euro in March of this year. It has now decided to hover within striking distance of 1.10 ever since.
Perhaps the US will continue a policy of low rates and receive low growth for quite some time to come, and as Europe joins the ZIRP conga line there is really very little to tell these two apart – financially speaking of course. The bottom line appears to be that there is no evidence that either the US or Europe will lead the way to significant growth in the near future.
Perhaps the sector that paints the clearest picture of global growth is the market price of commodities, and right now most are at very low levels and feeling like they are headed lower. Looking at the price of oil or copper for example shows that the markets have set an expectation of significantly lower demand. Especially within copper which remains the electrical conductor of choice. These and other commodity price declines shout slow global growth.
Throwing all these factors into a salad bowl leads me to suggest that the US and Europe will have a slowly growing or flat economy for the time being. I don’t believe in looking too very far ahead in these markets, especially with a host of global trouble spots stalking us from the edges of our attention.
Just look at Japan, who has used a ZIRP-like policy for something like 20 years now to unsuccessfully boost their economy. Maybe they didn’t do it right. Maybe they didn’t do enough. Maybe they did too much. Maybe their infrastructure could only support so much growth. Regardless, using Japan to provide a look at how our own economy might expand does not feel so good right now.
So for now the Fed has spoken, and we have listened to what the markets have whispered. Each seems to be full of concern and caution both for the global economy and right here at home. But at my core here at EverBank, I am an optimist. I’ll put up the storm screens in case the rain turns my way, but I’ll still be dressing for green grass and high tides.