Federal Reserve announces first rise in US interest rates since 2006

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The Guardian / December 16, 2015

US central bank signals end to seven years of a monetary policy that began amid the worst financial crisis since the Great Depression

The Federal Reserve raised interest rates on Wednesday, ending an extraordinary period of government intervention in the financial markets that started at the height of the recession.

After holding its benchmark federal-funds rate near zero for seven years, the Fed increased rates a quarter-percentage point. The move signals the end of a monetary policy that began amid the worst financial crisis since the Great Depression.

In a statement, the Fed said economic activity had been “expanding at a moderate pace. Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further.”

Given the economic outlook, and “recognizing the time it takes for policy actions to affect future economic outcomes”, the Fed decided to raise the target range for the federal funds rate a quarter point, the first such rise in close to a decade.

The central bank signalled more increases to come “with gradual adjustments in the stance of monetary policy” and argued that “economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen”.

At a press conference, Fed chair Janet Yellen said: “This action marks the end of an extraordinary seven-year period during which the federal funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression.”

She said the economy “has come a long way”, though normalization “is likely to proceed gradually”, and “inflation continues to run below our longer-run objective”.

The US has now added new jobs every month since October 2010. In November, the economy added 211,000 jobs and has added an average of 237,000 jobs a month over the past 12 months.

However, some have expressed concern about the move. Inflation appears to be under control – mitigating an imminent need to slow the economy by raising rates. And there are still signs of weakness in the jobs market, with historically high numbers of people no longer looking for work.

Ahead of the meeting, Richard Trumka, president of the US’s largest union federation, the AFL-CIO, urged the Fed to “avoid making a mistake” by raising interest rates.

“Too many working people are not feeling the economic recovery because of stagnant wages. In the months to come, the Fed should focus on the policy goal that real wages should rise with productivity. Working people deserve to lead better lives by sharing in the wealth we all create,” he said.

After the announcement, Senator Bernie Sanders, a Democratic presidential candidate, denounced the move as “bad news for working families”.

“At a time when real unemployment is nearly 10% and youth unemployment is off the charts, we need to do everything possible to create millions of good-paying jobs and raise the wages of the American people. The Fed should act with the same sense of urgency to rebuild the disappearing middle class as it did to bail out Wall Street banks seven years ago,” he wrote in a blogpost.

Stock markets around the world had risen on anticipation of the move, a clear signal that the US has shaken off the aftermath of the last recession. The zero rate policy was introduced by Yellen’s predecessor, Ben Bernanke, on 16 December 2008, exactly seven years ago. At the time, global stock markets were in turmoil following the bursting of a mortgage-backed financial bubble that triggered a global recession.

Bernanke backed the zero rate move with a massive bond buying programme, spending billions to buy Treasury- and mortgage-backed bonds in a move aimed at keeping rates low and encouraging investment, a policy known as quantitative easing (QE). QE ended last October.

Gus Faucher, senior macroeconomist at PNC, said the policy had been a success. “If you compare the US to other industrial economies, the recovery in the US has been better,” he said. “You can see proof of that in Japan and Europe now, where they have decided that QE is the way to go.”

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The Guardian view on the US interest rate rise: risky and premature

The Guardian (editorial) / December 16, 2015

It has been eight years since the US slipped into recession, and seven since it dawned upon central bankers that they were not merely enduring a storm, but sailing in uncharted waters. The unthinkable suddenly became the unavoidable: some institutions were left to collapse, others were nationalised, and the electronic printing presses were set whirring. Interest rates were slashed to virtually zero, lower than ever before, and then left there. In the pre-crisis world, this ultra-cheap money would have spurred cavalier investments, wild pay demands, and – soon enough – inflation. But this slump defied the old models. Growth came back only slowly, and even after it did prices and pay remained eerily stagnant.

By comparison with the UK and Europe, it is true, the US did enjoy certain advantages. It was spared Osborne-style retrenchment in the aftermath of the crash, and – when a nascent recovery stirred – it wasn’t choked by flawed currency union. Output did grow, unemployment did fall, and America settled into a tolerable if lacklustre new normal. For the Federal Reserve, the question became whether it was normal enough for it to revert to the old maps, which pointed to raising interest rates. For chair Janet Yellen, navigating by an old map must feel more reassuring than steering with no map at all. For market sentiment, too, there is comfort in the symbolic declaration of “emergency over” that a rate rise provides, which is why stock prices rallied ahead of Wednesday’s move, even though the immediate effect of costlier borrowing is negative for profits.

So it is reassuring for America to feel like it is back in familiar waters – until it transpires that it is not. The quarter-point rate rise addresses one potentially serious problem, but does so in the wrong way. QE dollars have puffed up the price of some assets, and if that puffing goes unchecked, the next bubble and bust could begin. The right way to tackle speculative investment, however, is through targeted regulatory curbs on lending for speculative purposes, not by raising borrowing costs for all investments, including those that America needs. The justification for higher rates should be a real economy moving at an unsustainable pelt. There’s no sign of that.

Unemployment has fallen, but it doesn’t mean what it used to before so many jobseekers became too discouraged to seek; the overall employment rate is low. Inflation is forecast to creep back to target, but that has been true many times since the crash, and it has consistently undershot. Inflation has been stuck below the 2% target for much of the post-2008 era, and so the rate rise should have awaited it bursting through this threshold. But it remains well short on all measures, and close to zero on some. The biggest judgment concerns the recovery’s strength. Growth has recently been respectable, but the bounceback needs to be measured against the crash before, and in that context it is less impressive. Real GDP per head has, on average, inched up by only a fraction of a percent annually since late 2007. By any ordinary standards that represents seven lost years for living standards, and all the more so because the very rich have grabbed so much of such growth as there has been.

Even though the Fed was careful to signal that it will tread cautiously in relation to future rate rises, the dollar’s might in the world’s financial system remains such that other countries could be forced to follow suit, with particularly serious implications for some developing economies. Since the crisis other central banks, from Israel to New Zealand, tried raising rates before being forced into reverse. If the chain reaction proves severe the question is whether the US, too, could be beating a retreat. The closest parallel, perhaps, is with Japan, which briefly raised rates from the floor in 2000, a decade into the long stagnation that dogs it still. Japan discovered in 2000 how painfully different its new normal was from its old, a painful lesson that the Fed may yet have to learn.

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U.S. Businesses Worry Stronger Dollar May Weigh on Growth and Exports

The Wall Street Journal / December 16, 2015

American businesses fretted that the first interest rate increase in seven years came at a time when a strong U.S. dollaralready is sapping demand for exports and low energy and commodity prices are weighing on growth in the industrial economy.

The Federal Reserve’s move Wednesday to raise short-term rates by a quarter percentage point was hardly a surprise to U.S. executives, but it comes as industrial manufacturers such as 3M Co. and Honeywell International Inc. offer cautious sales forecasts, as agriculture commodities are in their third year of declining prices, as transportation firms contend with sagging freight volumes, and as food and beverage companies struggle with the strong dollar sapping sales growth.

In making its move to raise rates, the Fed pointed to a strengthening U.S. labor market, more robust household spending and increasing business investment, while noting that exports have been soft. The Fed officials said they expect more gradual rate increases in the coming years.

That assessment, however, didn’t jibe with what some businesses are experiencing.

“We’re worried because we’re seeing leading indicators showing the economy is not in great shape,” said Glenn Riggs, senior vice president at Odyssey Logistics & Transportation, which books freight transportation for businesses and operates a fleet of about 300 trucks. “If they raise interest rates and things further slow down, that would be a bigger worry.”

Freight volumes sagged this fall, as manufacturing activity slowed and retailers cut back on imports. Further interest rate hikes also could increase the cost of borrowing to upgrade trucking fleets, Mr. Riggs said.

Major businesses from AT&T Inc. to Johnson & Johnson to International Flavors & Fragrances Inc. played down the immediate impact of Wednesday’s rate increase on business prospects.

“I think to a certain extent, having 10 years with no interest rate increases is unnatural,” said General Electric Co. Chief Executive Jeff Immelt. “And I think what’s difficult is there’s just nothing inflationary. And I think that makes it harder for the regulators to figure out what to do.”​

Longer term, however, further interest rate hikes could add to businesses’ borrowing costs, cool capital spending, and prompt a reassessment of inventory levels.

Jane Morreau, chief financial officer at Jack Daniel’s maker Brown-Forman Corp. , said the real effect will be further strengthening the U.S. dollar—an issue that already is weighing on results at beverage alcohol companies.

Earlier this month, Brown-Forman said that it expects weakening foreign currencies in markets such as Russia and Australia to negatively affect results by 5 cents per share during its current fiscal year.

But Ms. Morreau said she trusts that the rate increase signals “an improving U.S. economy, which could benefit our business.” The U.S. accounts for about 40% of the company’s sales.

General Motors Co. and home improvement retailer Lowe’s Cos. said the Fed’s decision reflects the strength in the U.S. economy that the auto and housing industries have been experiencing.

“Auto sales are at a new peak,” a GM spokesman said. “We don’t expect the rate hike to have any measurable impact on new vehicles sales given the underlying strength of the U.S. economy.”

Lowe’s Cos. Chief Financial Officer Bob Hull said the prospect of higher mortgage and borrowing rates could prompt prospective home buyers to act sooner, and jolt some homeowners to splurge on major renovations.

Mr. Hull expects the housing market to only slow after the 30-year fixed mortgage rates exceed 6% from their current level of about 4%.

Still, many companies have been citing weak economic growth around the globe.

Honeywell forecast sales growth in its core businesses, excluding acquisitions, of just 1% to 2% next year largely due to the troubles in the oil and gas sector. “We’re exiting 2015 at a slower growth rates than we had anticipated at this time last year,” Chief Financial Officer Tom Szlosek said Wednesday before the Fed’s announcement.

U.S. farmers already struggling with lower prices of major crops such as corn and soybeans for the third consecutive year could be further hurt.

Rising global crop stockpiles and the strengthening of the dollar have weighed on U.S. grain exports. And a string of benchmark rate increases at a time when central bankers in Japan and Europe are easing monetary policy would further fuel the dollar’s rise, analysts said.

“If we see a rate increase, it just reinforces the economic health of the U.S. and reinforces the backing of a strong dollar, which is overall a negative for the farm segment,” said Joe Lardy, research manager for the brokerage unit of CHS Inc., the biggest U.S. farm cooperative.

Ron DeFeo, executive chairman of Terex Corp. , a maker of cranes and other heavy machinery, said the Fed’s move was positive in that it “takes some uncertainty away.”

For now, weak commodity and oil prices have plunged parts of industry into “recession-like conditions,” Mr. DeFeo said, but consumers are doing better and their spending eventually should boost manufacturing.

Meanwhile, Ryan Lance, chief executive of ConocoPhillips, said that the interest rate increase, which the Federal Reserve hopes will spur inflation, is at odds with the current reality for energy companies, which are in the midst of aggressive cost cutting.

In “our business that’s a concept that is completely out of the radar screen right now,” Mr. Lance told an audience in New York at the Council on Foreign Relations. “I review every week what our deflation capture numbers are.”

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Central banks are casinos. They print money as if they were manufacturing endless numbers of chips that they’ll never have to redeem. Actually a casino is an apt description for today’s global monetary policy.

There is a well-known “foolproof” system in gambling circles that is sophisticatedly called the “Martingale”. I used to call it “double up to catch up” at my fraternity’s poker table where I was consistently frustrated (loser) – not because I used Martingale but because I wasn’t a good bluffer.

Today’s central bankers use both tactics to their success – at least for now. They bluff or at least convince investors that they will keep interest rates low for extended periods of time and if that fails, they use Quantitative Easing (QE) with a Martingale flavor. Martingale theorizes that if you lose one bet, you just double the next one to get back to even, but if you lose that one you do it again and again until you win.

Given an endless pool of “chips”, the theory is nearly mathematically certain to succeed, and in today’s global monetary system, central bankers are doing just that. Japan for years has doubled down on its QE and Mario Draghi’s statement of several years past, “Whatever it takes” – is a Martingale promise in disguise. It vows to get the Euroland economy back to “even” and inflation up to 2% by increasing QE and the collateral it buys until the Euro currency declines, the EZ economy improves, and inflation approaches target. Currently the European Central Bank (ECB) buys nearly 55 billion Euros a month, and this Thursday they will up the ante – Martingale or bust!

How long can this keep going on? Well, theoretically as long as there are financial assets (including stocks) to buy. Practically the limit is really the value of the central bank’s base currency. If investors lose faith in a reasonable range for a country’s currency, then inflation will quickly hit targets and then some. Venezuela, Argentina, and Zimbabwe are modern day examples. Germany’s Weimar Republic is a great historical one.

Theoretically, if the whole developed global economy did this at the same relative pace and stopped at the right time, they could successfully reflate and produce a little bit of inflation and a little bit of growth and save the globe from the dreaded throes of deflation. That is what they are trying to do – Quantitative Easing, Martingale style – and so far, so good, I guess – although no rational observer would call these post Lehman efforts a success.

That they haven’t really succeeded is a testament to what I and others have theorized for some time. Martingale QE’s and resultant artificially low interest rates carry distinctive white blood cells, not oxygenated red ones, as they wind their way through the economy’s corpus: they keep alive zombie corporations that are unproductive; they destroy business models such as insurance companies and pension funds because yields are too low to pay promised benefits; they turn savers into financial eunuchs, unable to reproduce and grow their retirement funds to maintain expected future lifestyles. More sophisticated economists such as Kenneth Rogoff and Carmen Reinhart label this “financial repression”. Euthanasia of the saver is the result if it continues too long.

But this is theorizing much like Schrödinger’s cat. How many people care about the existence of a quantum feline? (A few, thankfully, but not many.) Market observers say “show me the money” and when they look inside the box, they want to see some, so let’s get down to business.

How does all this play out? Timing is the key because as gamblers know there isn’t an endless stream of Martingale chips – even for central bankers acting in unison. One day the negative feedback loop on the real economy will halt the ascent of stock and bond prices and investors will look around like Wile E. Coyote wondering how far is down. But when? When does Martingale meet its inevitable fate? I really don’t know; I’m just certain it will. Doesn’t help you much, does it. Except to argue that much like time is relative to the speed of light, the faster and faster central bankers press the monetary button, the greater and greater the relative risk of owning financial assets. I would gradually de-risk portfolios as we move into 2016. Less credit risk, reduced equity exposure, placing more emphasis on the return of your money than a double digit return on your money. Even Martingale casinos eventually fail. They may not run out of chips but like Atlantic City, the gamblers eventually go home, and their doors close.

William (Bill) H. Gross

December 3, 2015