The Fed did it! After nine years since the last rate hike, and following seven years of near zero interest rates, the Fed and Janet Yellen last Wednesday finally raised short-term rates by a whopping one quarter of one percent. The financial markets, which had been displaying concern and worry during the decision’s build-up, largely sloughed it off.
Listening to Yellen during her follow-on press conference, what strikes me is the Fed’s propensity to represent the consensus view. As economic cheerleaders, this is quite natural for the Fed, of course. What else could they say and how else could they feel other than believe the near-term future will resemble the recent past? The past trend is always the future trend to consensus thinkers. This is precisely why the majority of investors fail to anticipate a change in the trend.
For example, as the calendar turns, many will read market prognostications for the year ahead. Already I have noticed news stories that indicate stock market returns will be in the range of 5% to 10%. For as long as I can remember, I’ve seen this range of returns anticipated time and time again. Not coincidentally, that range fits the long-term historical return of stocks in the US.
Published along with the news release of the Fed’s decision last Wednesday, Fed governors made public their own individual projections of economic growth, inflation expectations and unemployment over the next few years along with their long-range expectations of these same measures. What’s striking about this report is their consistent lowering of economic growth and inflation relative to their prior projections. The Fed has consistently been too optimistic.
Like many economists and investors, the Fed has looked for inflation to rise back to its long range target of 2% per year. Today, that measure sits closer to 1%. The consistent undershoot of inflation is not a phenomenon of the US alone. Many of the largest economies in the world are also experiencing what’s known as disinflation – a decrease in the rate of inflation. This was true prior to the drop in oil prices and does raise questions about possible structural issues for the global economy that may lead to continued subdued inflation rates.
It’s fair to say that the largest concern of all central bankers is for disinflation to morph into deflation – that is, an outright drop in prices. This is what Japan struggles with today following their own financial crisis many decades ago. Global central bankers, through zero interest rates and asset purchases, responded to this prospect with an unparalleled monetary experiment.
The question is, did the experiment work? With the Fed finally raising interest rates off the floor, the largest impact may be in the confidence “signaling” impact for investors. In other words, if the Fed feels it’s safe to finally raise rates after seven years in credit crisis-recovery mode, they must feel the trend is their friend. Outside of asset price appreciation and a now-larger pile of low-cost debt, a definitive answer to the question remains unanswered.
