Risk/Reward Vol. 259
THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.
“Say what you mean
Mean what you say
Think about the words
That you’re using”---lyrics from “Say What You Mean” sung by The Moody Blues
“And I don't give a damn about a greenback dollar
Spend it fast as I can/For a wailin song and a good guitar
The only thing that I understand, poor boy”---lyrics from “Greenback Dollar” sung by Hoyt Axton
“It was an itsy bitsy, teenie, weenie, yellow polka dot bikini
That she wore for the first time today”---lyrics from “Itsy Bitsy….” sung by Brian Hyland
Going into this week’s meeting of the Federal Reserve’s Open Market Committee (FOMC), the conventional wisdom was that if the FOMC removed the word “patient” from its forward guidance, an interest rate increase could be expected in June. In addition, it was believed that any such removal would cause the dollar to rise, the interest rate on the 10Year US Treasury to spike, the price of oil to drop and the stock market to plummet. “Patient” was removed, but in so doing the FOMC did not “Say what it meant/Or mean what it said. Instead, Chair Yellen emphasized that removal of the word “patient” does not mean that the FOMC will be “impatient” when it comes to any rate increase. Really? How disappointing, Janet. Is this casuistic double speak any kind of guidance? Did you really “think about the words/That you’re using?” To explain the ensuing spike in the stock market, the precipitous drop in the rate on the US Treasury 10Year Bond (10Year), the decline in the dollar vs. the euro and the rise in oil prices (all of which occurred in the 90 minutes between the issuance of FOMC press release and the end of Yellen’s press conference), commentators pointed to the obvious synonymity of “patient” and “not impatient” and to the following data points. First, the FOMC lowered the natural unemployment rate (that is, the rate at which wages will impact inflation) from 5.5-5.2% to 5.2-5% thereby effectively removing low unemployment as a reason to raise rates (as predicted in Vol. 254 www.riskrewardblog.blogspot.com ). Second, the FOMC lowered its 2015 GDP growth forecast from 2.6-3.0% to 2.3-2.7%. Third, the FOMC is now predicting ultra-low inflation for 2015 of 0.6-0.8%, well below its target of 2%. All of these augur a later rather than sooner rate increase, if one at all.
Mentioned only in passing by Yellen, but of equal importance to the three points above was the FOMC’s concern about the currency war of which I wrote last week. (See Vol. 258 www.riskrewardblog.blogspot.com). Raising rates any time soon will have the side effect of strengthening the dollar even more versus every other world currency. And a strong dollar already has begun to negatively impact our economy. As discussed last week, corporate profits for multinational corporations are down due in large part to currency exchange rates. Exports are suffering. And foreign tourists are staying home in droves. After all, one hundred dollar’s worth of entertainment which cost Eurotourists only sixty nine euros last year now costs them ninety six euros. By its charter, the Federal Reserve is to address only domestic economic issues. But clearly, domestic issues are “not the only thing it understands.” Indeed, it would be folly for the Fed to “not give a damn about (anything other than) a greenback dollar” because in this world, no currency exists in a vacuum.
The above points may have grabbed the attention of commentators this week, but I predict that the data point with the most significant long term impact is the shift in the individual FOMC member’s predictions as to what the year-end 2015 and 2016 overnight borrowing rates will be. These predictions are plotted on a graph called the “dot plot.” From these “itsy, bitsy, teeny, weeny polka dots”, one could see “for the first time today” a significant slowing of the pace of rate increases should they ever begin. The consensus of the members is now that at year end 2015 the overnight (or Fed funds) rate will be 0.625% as opposed to their consensus just three months ago that the rate would be 1.125%. Equally telling was the lowering of the consensus year end 2016 rate from 2.5% to 1.875%. These changes are significant for all investors, but particularly for income investors; those whose securities are priced in relation to the yield on the benchmark US 10Year. Once the dust settles from this week’s volatility, I can repurchase what I sold with more confidence that any profit I garner will not be eroded by a spike in the 10Year rate and a concomitant drop in price---even if a modest rate increase is instituted in June.
On Wednesday between 1:30 and 3:30 pm, the DJIA average spiked 2% and the yield on the bellwether 10Year dropped 6%. Billions of dollars were made or lost, all because a few, enigmatic words were written and/or spoken by a handful of economists. This leads one to ponder the awesome power that we have conferred on the Federal Reserve Board. No member is elected, and during one’s term, no member is answerable to anyone. Is this wise? Well, at present, perhaps. The alternative is leaving such weighty decisions to a community organizer or to an overly tanned, weepy weekend golfer. In the long run, however, the role of the Fed should be re-examined. Until then, we, like the Moody Blues, are left with the following “Question” about the Fed:
“Why do we never get an answer
When we're knocking at the door
It's not the way that you say it
When you do those things to me.
It's more the way that you mean it
When you tell me what will be”.
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