Yahoo Finance Fed might remind forgetful investors that rate cycles can hurt
New research finds that the agony of running a marathon fades from memory quite a bit over time. That, I guess, is why so many people sign up for the same painful 26-mile ordeal over and over again.
Investors might be experiencing a similar effect when it comes to running the course of Federal Reserve interest rate cycles. For more than two years, the market has been on alert for the Fed to tighten up monetary policy, ever since Ben Bernanke touched off the “taper tantrum” with hints of an eventual end to its bond-buying plan.
The pain of that bond-market tantrum has apparently faded, though, and since then it has consistently paid to bet on the Fed to push off into the indeterminate future the date when it might begin truly cinching up its easy-money policies.
The Fed’s own economic projections have repeatedly proven too optimistic, inflation measures have remained depressed and Fed Chair Janet Yellen has shown a knack for soothing investors’ anxiety about any jarring moves by the central bank.Yet it’s possible, as we await the Fed’s policy statement this afternoon, that investors are extrapolating this pattern too far.
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Because right now, Fed Chair Janet Yellen faces a serious disconnect between what the market anticipates and what her stated and likely intentions are. Bond futures traders have priced in only a 25% chance that the Fed will lift short-term rates from near zero by September.
But the Fed’s latest expectation is that it will have begun the process by then. Today’s statement from Yellen and her colleagues could be aimed at bridging this gap in expectations. This could be done through comments describing weak first-quarter growth as “temporary” and language suggesting the economy and inflation are poised to pick up. It’s popular on Wall Street to scoff that whenever the Fed eventually pushes overnight rates up to, say, half a percent, it should be a non-event for stocks or the economy. Some are even eager to get the so-called normalization process started.
And in the grand scheme this is probably true: By the time it happens, it will be universally expected, and maybe priced into markets. But on the way to that point, the markets might have to make an uncomfortable peace with how the process will unfold. A rate hike will not materially raise the cost of money, but it will increase the frictional tax on financial-market dealings and send a signal to leveraged players that their fun might be up.
These things are always complicated, but this time around it’s even more vexing because it has been so long since investors have run this part of the rate-cycle race. The last time the Fed initiated a tightening process was almost 11 years ago. It went fine, but the move was accompanied by less suspense and lower stakes. And that hike came only a year after the final post-recession rate cut.
Here, it’s been almost seven years since rates were cut and nearly nine since the final rate increase of the pre-crisis period. We’ve forgotten how these races feel when we’re in them. The meeting and statement today might indeed be relatively uneventful as the consensus seems to believe.
But any sharp reminder that Yellen wishes for the grounds to move sooner than the market expects should ruffle the Treasury bond market (^TNX) and perhaps rally the dollar (UUP) and boost bank stocks (KBE) yet again on the idea that their interest income could finally go up. Those are your areas of the market to watch as we try to figure out whether this stretch of road will deliver any pain to investors.
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