Wall Street has been obsessed with the actions of the Federal Reserve for at least as long as the older of us has been investing. On Thursday afternoons in the 1970’s, everyone watched the Dow Jones news wire for the money supply report that might hold clues about the Fed’s next policy move. More recently, the Fed has been extraordinarily “accommodative” in the six years since the financial crisis, and there is considerable investor anxiety about how stocks will react to a return to “normal” interest rates. It is almost comical to watch the stock market rally or swoon in response to every small bit of economic data. The logic seems to be that a sign of economic strength (good news) is “bad” because it might encourage the Fed to abandon its “zero interest rate policy” (ZIRP). Conversely, a sign of economic weakness often triggers a rally since it may discourage the Fed from tightening.
The Fed’s (and the Treasury’s) actions immediately after the Lehman failure were important and effective. In succeeding years, though, the creation of trillions of new dollars and their use to pump up asset prices (via “quantitative easing” or “QE”) may prove to have been counter-productive. It seems likely that we have “borrowed” investment gains from the future via QE. More importantly, to the extent speculators have used cheap, short-term credit to buy (riskier) higher yielding assets (“carry trades”), they face potential trading losses if rates rise suddenly. Their scramble to exit these trades could trigger market liquidity issues.
Another interesting result of aggressive central bank activity, in Europe and Japan as well as the U.S., is that a significant amount of sovereign debt (bonds issued by countries rather than companies) now carries negative
interest rates. This is unprecedented. One might call it surreal. Berkshire Hathaway Vice Chairman Charlie Munger
) admits to being “flabbergasted” by the negative yields. He says, “…of course I’m confused. Anybody who is intelligent who is not confused doesn’t understand the situation very well. If you find it puzzling, your brain is working correctly.” (Forbes, 3/26/2015) Charlie has a way with words. Continue Reading »