Skip to main content

Don't Fight The Fed

This was one of the key mantra’s I heard repeatedly early in my career when I traded mortgage-backed securities and sat on the bond trading desks at two major investment banking firms.  Back then, in the 1980’s, the mantra seemed to me to overstate the power of the Fed’s ability to move markets.  The concept of QE, or printing money to buy securities, was unimaginable then.  The main power of the Fed rested in its ability to influence only the shortest end of the yield curve (or short term rates, for those of you who don’t come from the finance world).   It seemed back then, in the days of what seemed to be free markets, that the forces of the marketplace, expressed by the thousands of participants coming together to by and sell securities and to borrow and lend money, set the more important longer term rates that directly affected most borrowings – including home mortgages, commercial real estate loans, and corporate borrowings.
In the wake of what we now call The Great Recession, the Fed has changed its approach to markets rather dramatically, as many know but I believe too few question.  For the past five years the Fed has become the major mover of financial markets, literally not permitting interest rates to rise.  Of course, given our country’s relative financial health and stability when compared to the rest of the world, it isn’t hard to say that this policy has worked magically and we ought to applaud those at the Fed for a job well done.  If only life was that simple. 

With rates as low as they’ve been, investors who require a reasonable return on their capital, historically in the vicinity of 6-8%, have been forced to shun high quality fixed income securities and reallocate primarily into stocks and lower quality (high yield) fixed income.  This has created a situation whereby a retrenchment of the Fed from its market dominating position and commitment to ultra-low rates is very difficult, if not impossible.  Such a retrenchment would certainly cause rates to drift higher, which would have a negative impact on general stock prices, as well as home values and real estate values overall.  The market losses and “negative wealth effect” this would cause is surely weighing heavily upon the minds of those at the Fed today.  Further complicating matters is the fact that the Fed, with its immense balance sheet and its ability to manage the market, is generating significant profits which flow through to Treasury and are now being counted upon to pay for a good part of our nation’s budget.  In sum, it is difficult to imagine how the Fed will reverse the dominating position it has taken up since 2009. 

As I reflect upon the market that I grew up in, which was driven by the input of many thousands, I wonder what all of this means for the future of finance in the U.S.  And, finance being an integral element of our society, I am deeply concerned about the trend towards government dominance of our markets.  Freedom, like air or like a pain-free body, is something that most people take for granted until it is lost.  Freedom seems to be under siege in the U.S. and in the world, and a free market financial system has long been a cornerstone of American freedom.  I’ve heard many recently applauding those who have brought us to this place, crediting them with having sufficiently revived our economy.  I fear that the price we will pay for this fix will ultimately prove to be very high.

Popular posts from this blog

Taxes and Hyperbole

There is a new tax code in the U.S., and this is indeed a “Yuuuge” deal. As far as I can tell, it is as close to an unmitigated home run for America as can be. Is it perfect? Of course, it’s not. The code retains its unwieldy size and complexity, largely as a result of compromises made in order to bribe congressmen and senators for their votes. Until we get term limits, it seems we’re stuck with a tax code that is big and complex. However, it does hit the mark on a few key issues: most every taxpayer will now pay less to the federal government (except those in states with ridiculously mismanaged economies who now will be forced to hold their state politicians more accountable); and our businesses, large and small alike, will remit less of their profits to the federal government and will be liberated to invest that savings into growth – which will surely create job and wage growth in the productive private sector.

You Need to Ask the Right Question

If you ask the wrong questions, the answers will probably also always be wrong, and even irrelevant.  This might seem obvious, but I’ve noticed that this truth is often completely overlooked, and even by the world’s most intelligent. While I’m certain this is so in every facet of life, for the purpose of this short paper I will focus on the investment/finance world.

Interest Rates & The Trade War

These are the twin bogeymen that the hysterical media will continue to lean on to drive fear into the hearts of men and women and keep them glued to their TV sets for the predictable backwards looking drivel. Here is a different perspective for you to chew on:

Interest rates cannot go up by too much. Our nation has to service more than $20T of national debt and must also maintain a massive social safety net that will increase that debt by a further 50% before Trump’s second term ends. All the rest of the analysis is unimportant.