The Federal Open Market Committee just released their March Fed meeting results and hiked rates again by a widely anticipated 25 basis points. This was new Federal Reserve President Jerome Powell’s first meeting. If you were expecting something different, I’m sure you’re disappointed right around now.
What appears a continuation of prior policy, the message was for additional gradual rate hikes and hopes of low volatility steered by transparent Fed comments.
The FOMC also continued their policy of releasing their dot plot of expected Federal Funds target rates over the next 3 years as well as longer run expectations by FOMC participants. This is an additional tool that the FOMC has been using to diminish volatility in the markets. The Fed believes by showing expected paths of Fed Funds, the Fed gives more certainty on future policy to have a smoothed transition to higher yields from the current depressed yields stemming from excessive monetary accommodation over the past 10 years.
The Fed drove yields in the US and globally to extremely low levels unjustified by fundamentals in hopes to create conditions they thought were necessary after the 2008 financial crisis. Their excessive monetary accommodation replaced the need for any good fiscal policy. In driving yields to historic low levels, the Fed created the potential for a systemic financial catastrophe upon the unwind of their unconventional and unprecedented policies.
Now the world relies on these dot plots to reactively understand the direction and level of the Federal Funds rate and therefore yields in the US and globally in general. This works fine if you want a reactionary function instead of extrapolating economic data and forward looking (by definition) forecasts for rates. Markets are supposed to be priced based on fundamental economic projections. Since the Federal Reserve manipulated rates over the last 10 years ignoring fundamentals, the investment community has become conditioned to follow the Fed, their communication, dot plots and not fundamentals.
Does it really take a leap of faith to expect the dot plots for future Federal Funds to increase when still at depressionary levels with the economy at full employment and still strengthening? And now that one member’s dots shows the Fed Funds rate is expected to rise to just under 5% by 2020, does it really take a genius to extrapolate that others will follow if growth and excess capacity continues on the same trajectory? And do we really have to wait reactively to get a new set of dot plots to confirm that?
Or maybe we should again focus on the fundamentals and stop being led to the trough when it’s time to feed. One of the most extreme costs to Fed policy has been the conditioning of markets and investors to become over reliant on Federal Reserve communication. Past Fed policy during a time of excess capacity was on cruise control only focusing on the Fed chairman’s own preferences for monetary policy. This was to clean up a financial crisis. These conditions are over. Now that excess capacity has been used up, the Fed’s preferences will take a back seat and forced to respond to the ever changing fundamentals. And the Fed has been notoriously poor on forecasting economic projections. Or to say it another way, the Fed has no confidence in what the future has in store and will be responding reactively to changing conditions.
I hope markets and investors catch on and proactively anticipate the future again based on projecting economic fundamentals instead of looking through the Feds rear view mirror. To maintain their credibility, the Fed may be getting ready to remove, or limit use of their communal rear view mirror. And the roads ahead look to be quite curvy.
by Michael Carino, Greenwich Endeavors, 3/21/18
Michael Carino is the CEO of Greenwich Endeavors and has been a fund manager and owner for more than 20 years. He has positions that benefit from a normalized bond market and higher yields.