The Federal Reserve is an interesting study in public relations. The Fed has
twelve districts that release statements and publish studies. The Federal Reserve
Board is comprised of seven members who often make public statements about
monetary policy. The chair of the Federal Reserve Board also testifies and
conducts Q&A sessions with the media. Often, statements coming from the
various sources within the Fed seem to be highly contradictory and confusing,
something that serves
a purpose in the realm of monetary policy.
Fed Cares About Inflation Expectations
Experienced investors know central bankers care about their legacy, as most
professionals do. While casual investors may believe all the Fed cares about
is higher stock prices, the Fed is genuinely concerned about allowing inflation
to get ahead of them. If inflation expectations begin to pick up, it can change
habits, which ultimately can lead to real world inflation.
Fisher's Shot Across The Bow
On Sunday night, The
Wall Street Journal published an opinion piece by Richard Fisher, president
of the Federal Reserve Bank of Dallas. The text serves as a warning to complacent
investors that the Fed cannot keep interest rates near zero indefinitely.
The op-ed opens with a single sentence paragraph:
"I have grown increasingly concerned about the risks posed by current
monetary policy."
That is a pretty strong opening statement meant to get the attention of investors
and businesses impacted by interest rates.
Making The Same Mistakes?
If you were investing during the dot-com bubble, you remember the Fed failed
to tighten margin requirements, which allowed speculation to run rampant. The
Fed is often criticized for "keeping rates too low for too long" between 2003
and 2005. For example, the Federal Funds Rate was at 2.25% in January 2005.
In the July 27, 2014 Wall Street Journal (WSJ) opinion piece, Fisher states:
"I believe we are at risk of doing what the Fed has too often done:
overstaying our welcome by staying too loose, too long."
Incentives To Take On Risk
Fisher noted that Janet Yellen was also aware of the potential risks of maintaining
the Fed's current stance. From Fisher's WSJ piece:
"In her recent lecture at the International Monetary Fund, Fed Chair Janet
Yellen said, 'I am also mindful of the potential for low interest rates
to heighten the incentives of financial market participants to reach for
yield and take on risk, and of the limits of macroprudential measures to
address these and other financial stability concerns.' She added that '[a]ccordingly,
there may be times when an adjustment in monetary policy may be appropriate
to ameliorate emerging risks to financial stability.' I believe that
time is fast approaching."
Investment Implications - Good To Be Aware Of
Should we sprint for the equity exits after reading Fisher's comments? No.
However, it is good to be aware of the Fed's willingness to raise rates sooner
than many market participants believe. The risk is not related exclusively
to a rate increase. It is the timing of the rate increase that could catch
some investors off guard.
How do we use all this? Fed policy is one of many inputs impacting the battle
between bullish economic conviction and bearish economic conviction. As noted
on July
28, the market will guide us if we are willing to listen. Not much has
changed this week. Therefore, the 80% confident 20% concerned analysis in this
week's video still
applies. Therefore, we continue to hold a mix of stocks (SPY), leading sectors
(XLK), and a relatively small stake in bonds (TLT).
The possible market-spooking outcome this week or in the weeks ahead is if
the Fed signals an interest rate hike may be coming sooner rather than later.
Again, it is not the act of raising rates that matters, but the timing.
