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The Fed’s Gone Loco?

It has become increasingly clear that the stock market is testing the Fed at this exact moment. The market is seeing just how far it can push the new Chairman before he caves-in on his path to raise interest rates.  The sell-off in the equity market is about the Fed and how aggressive it is being with interest rate and how it is handling the economy. It has become increasingly evident.

Premium video content: The Market To Fed: You’ve Gone Loco

Neutral?

Yields on the 10-year Treasury are right back to where they were on October 3, when the stock market sell-off started.  Investors are not on-board with the Fed’s plans to continue to raise rates to whatever “neutral” is.

To be honest, how does the Fed determine where neutral is? Is it 4%, is it 5%, is it 3%? Does anybody know? That may very well be the biggest problem, it just an open-ended policy and nobody knows what it means or how many more hikes could be in store.

What is Normal?

I have always thought that the period from 1970 to mid-2000’s was the aberration for interest rates, not the present. It could very well be that rates are already above neutral. We should not measure today’s rates against the recent history between 1970 and 2000’s as “normal”. Because it was not historically normal, it was well beyond normal.

Lower

The chart below shows the 10-year U.S. Treasury rate going back to the year 1871. Where is neutral?  The average interest rate according to multpl.com  is 4.5%, the median is 3.85%. So I ask, at 3.1% today are pretty close to historical levels. One could even argue the average and median, stated above, is too high, given the bubble years.

Too Short-Sighted

Perhaps it is that the Fed’s view on the history of rates is too short-term.  This next chart is by far my favorite chart because it goes back to the year 1753, nearly 300 years worth of data.  I think you can count on your hand how many times the rate on the UK Consol rose above 5% before the year 1960. True, a different country, but are their similarities.

Again where is neutral?  If long-term bond rates have historically been between 3-5% then perhaps neutral on a short-term duration interest rate like the Fed Funds Rate or 3-Month Treasury bill should be somewhere lower. Perhaps the Fed is already at neutral or has even overshot neutral.

Where is Inflation?

I could see the argument to raise rates if inflation was out of hand. But a trimmed mean PCE of 1.99% is far from out of hand. Commodity prices such as Gold, Silver Platinum, Copper, Lumber, Sugar, and Oil are telling us inflation is far from out of hand.

Long-term bond rates on the 10-year are telling you inflation is far from out of hand.

Now the stock market is telling the Fed to stop its current rate tightening path.

We just better hope the Fed is listening, because things could get a lot worse if they don’t change course or indicate the cycle is closer to the end, then the beginning.

It makes November 7th Fed meeting more critical than most.

Photo Credit Via Flickr

Mott Capital Management, LLC is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future.

S&P 500, SP500, fed, rates, inflation