This week, the IMF, or International Monetary Fund, a 188-country global cooperative of nations working towards financial stability and sustainable growth, reiterated its call on the Fed to delay any interest rate hike until 2016.
According to IMF head Christine Lagarde (pictured below to the right) and other rate doves, inflation is in check and any premature tightening would undercut the fragile recovery currently taking place.
Of course Fed chief Janet Yellen (pictured below to the left) is on record as saying that it would be appropriate this year to raise the rate target and move towards normalizing monetary policy.
Continued Mixed Bag
Closely monitored economic indicators don’t appear to paint a picture of a dire need to tighten anytime soon. While official unemployment numbers appear to be dropping, “real” employment is constantly questioned along with the quality of jobs being created. Inflation in pockets of the economy, food for example, seems to offset deflation in others, energy in particular.
Meanwhile, the stock market continues to paint a fairly rosy picture of corporate America, but the same might not be said when we take a look at middle class economic data. Wages, savings rates, net household worth, amongst other points, would indicate a lack of advance on the part of Main Street U.S.A.
The continued plight of Euro problem child Greece continues to be well documented, and could certainly be factoring into Fed thinking. Yellen has said that USA direct exposure to the Greek crisis is negligible, but that “spillover: effects, depending on how the situation plays out might be felt.
The stock market, while often times reported as “salty” on the valuation front, seems to be taking a much needed breather thus far in 2015. Housing is also mixed month to month, but appears to generally be bouncing off the bottom. Still, the economy doesn’t appear headed for an overheated situation, which again points to a delay in tightening.
The Pressure’s On
With the IMF pressing for a continued status quo and others contending that a hike should have been implemented some time ago, the Fed is being pressured on both ends. And frankly it’s not particularly hard to see both points of view.
The prolonged period of ZIRP, which has bred “unnatural” monetary policy and ingrained new terms like “quantitative easing” into the minds of market watchers, is something we unquestionably need to distance ourselves from at some point. Yet, given the extent of the damage that the financial crisis brought about, and the delicacy of whatever rebound is occurring, a rush to move away from ZIRP – just to be away from it – seems imprudent.
So when the Fed meets again, it appears to be somewhat of a flip of the coin as to what they will do. Economic indicators, as would be typical, will be the primary influence on their decision, while ancillary factors like global conditions and hotspots (Greece) and stock market progression will be of peripheral focus. IMF lobbying and academic opinion may be appreciated and listened to, but certainly will not form the nexus of their reasoning.
What I Think They Will Do
My sense is that the Fed is locked and loaded, all but ready to move 25 basis points. Greece fallout jitters as well as the recent weakness in the stock market are somewhat of a wildcard. If stocks continue to weaken, my suspicion is the FOMC will probably delay once again. If the DOW remains in the 17500 area or higher, I think they will tighten. But like the IMF, I wonder if that is the smart thing to do. I’ve thought a full year exit from QE was warranted.
Theoretically, a 25 basis point move does not represent much. But since we’ve been in uncharted waters for so long now, these 25 basis points are a big deal, viewed as a significant positive hurdle to some and a significant risk to others. Clearly a return to normalized policy is healthy, but will it do something to economic psyche or create an unforeseen issue? Time will tell.
I’ve been advising a conservative mindset for quite a while now. This is not a time to take big risks or assume that you are a know it all. With stocks and bonds both trading with historically high valuations, a reversion to the mean would represent tremendous capital risk.
Diversification in equities and limiting exposure to highly speculative or highly levered stocks is probably a good idea. In terms of bonds, low duration, careful attention to credit, and laddered maturity are good ways to keep a portfolio insulated.
Of course with many predicting a long-term secular atmosphere of low rates, longer duration may not get you trouble. However, if you are long and wrong – either in stocks or multi-decade bonds you could be in for a lot of pain. Better to be wrong and out of the market than long and in the market.
Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.