It’s that time of the year again when all eyes in the investment world turn to Wyoming. Yea, I know, weird, right? But every year the Fed has a get-together in Jackson Hole to talk about, well, Fed stuff. A number of years ago they mused on using quantitative easing as a tool to manage the economy and financial markets. And lo and behold, quantitative easing was soon ubiquitous around the world. Last year Chairman Powell made the headlines when he said he was committed to battling inflation. I know, not a real shocker, but there isn’t much going on in the markets during the dog days of August.
Well, Powell’s comments this year were a touch tamer. Basically, he said the Fed is prepared to raise interest rates further if inflation isn’t on a convincing path towards the 2% goal. And if it is, he won’t. Not exactly groundbreaking. But the Fed is probably searching for a way to get themselves out of something of a predicament. They have been publishing a chart like the one below for some time now.
This is the Fed’s so-called dot-plot. It shows where the committee members see rates settling out in 2024, 2025, and beyond. As you can see, most board members think the Fed Funds rate will average roughly 2.5% over the long run. Some call this the terminal rate where monetary policy is neither restrictive nor expansionary. Another term is economic geekery – it’s called the R*.
But is this the right number? Many think not. Today’s Fed Funds rate is well over 5% and growth looks ok. After all, the Atlanta Fed’s guess for third quarter growth is running close to +6%.
A Fed Funds rate of 2.5% might have been neutral post Global Financial Crisis (GFC), but is that still the case today when fiscal spending is running as hot as it is?
The Fed’s quandary is how to guide this long-term rate higher if the fundamentals of the economy have truly changed. Some thought Powell might attempt such a balancing act today, but it wasn’t to be.
The bond market isn’t waiting around, though. After all, both 10-year and 2-year yields have hit multi-year highs lately.
And the rise in yields isn’t due to worries about inflation. All of the increase in rates is due to the so-called real yield, as you can see below.
This is the yield you earn on a 10-year Treasury Inflation Protected bond. There are a number of factors that can drive real yields higher. The downgrade probably didn’t help. The fiscal backdrop is certainly playing a part. But so is the fact that investors are betting that a neutral Fed Funds rate isn’t 2.5% in today’s world. It’s likely something higher.
But in the grand scheme of things, we are getting back to the state of the world before the financial crisis. Pre-2008 real yields were consistently over 2%.
Looked at this way, maybe the post GFC period is really the aberration, not what’s happened with rates recently.
(Other) Charts We Found Interesting
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Rising real yields is filtering through into mortgage rates. They hit their highest level since 2001 this week.
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As you would expect, mortgage activity is grinding to a halt.
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People are also borrowing less from their brokerage accounts.
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This chart is a bit complex, but basically it tells you that a huge percentage of daily trading volume comes from something other than people or institutions buying stocks as a long-term investment.
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Timing the market is hard. A recent Morningstar study tried to quantify how hard.
‘Our annual study of dollar-weighted returns (also known as investor returns) finds investors earned about 6% per year on the average dollar they invested in mutual funds and exchange-traded funds over the trailing 10 years ended Dec. 31, 2022. This is about 1.7 percentage points less than the total returns their fund investments generated over the same period. This shortfall, or gap, stems from poorly timed purchases and sales of fund shares, which cost investors roughly one fifth the return they would have earned if they had simply bought and held.’
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China no longer reports youth unemployment numbers. Probably safe to say the data is moving in the wrong direction.
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There’s always a bull market somewhere. The country is awash with breweries.
Have a good weekend
Charles Blankley
Principal
Chief Investment Officer
Gemmer Asset Management LLC
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