The FED Being Hesitant Isn’t Good News…

• The FED is telling us stressful times are on their way, why not position yourself in a win-win situation?
  
• We’ll summarize the good, neutral, and bad news.
  
• The reason why the FED is hesitant in raising rates is of global concern.
  

In our article on Friday, we discussed how important interest rates are for the stock market as higher interest rates pull stocks down while lower interest rates push stocks higher because people have lower required return rates.

A great place to look at what’s going to happen to interest rates is the FED’s minutes where members discuss long-running monetary policy frameworks. In today’s article, we’ll summarize and discuss the minutes from a perspective that goes beyond the obvious.


The FED discussed the following economic information: GDP expanded faster in Q3, inflation increased but is still running below the target of 2%, the unemployment rate remained at 5% with unemployment claims low, wages increased 2.5% in the trailing 12 months, and foreign real GDP growth appeared to pick up significantly in the third quarter.

Members judged that the information received since the Committee had met in September indicated that the labor market had continued to strengthen and that growth of economic activity had picked up.


Real private expenditures for business equipment and intellectual property were about flat in the third quarter. Total housing starts declined pushing real residential spending down (the latest data shows housing starts have since picked up again).

Broad stock price indexes, financing conditions, and consumer credit were little changed.

The Committee decided to maintain the target range for the federal funds rate at ¼ to ½ percent at this meeting although the case for an increase in the policy rate had continued to strengthen.


Manufacturing output has remained flat over the last two years reflecting weak export demand, spillovers from the earlier declines in crude oil and natural gas drilling, and slow domestic capital investment. The nominal U.S. international trade deficit widened in August relative to July, as imports rose more than exports (the rise in the dollar will not help this issue). The staff’s forecast for real GDP growth over the next couple of years was also slightly lower than in the previous projection, primarily reflecting the effects of higher assumed paths for the dollar and for crude oil prices.


What consistently comes to mind when reading the minutes is the FED’s obsession with providing liquidity in times of stress suggesting that such times will, unfortunately, come around as they have always done.

In this bull market, investors seem to have forgotten the possibility of stressful events happening and are willing to buy assets at ridiculous valuations. This concept is especially exacerbated by the boom in passive investing where funds and ETFs buy something just because it’s in a sector without looking at fundamentals. Be very careful with such investment vehicles, those will be the first to break when stressful times come around.

As the market is very segmented in relation to valuations and growth, it’s possible to position yourself so that you’ll benefit from further market growth but also limit the downside if something negative happens. Look at earnings, debt ratios, real growth rates, and cyclicality when assessing a company.

Further, the FED acknowledges the probability that neutral short-term interest rates could remain quite low. This would be good news for asset prices but not such good news for the economy and savers.


As our economic situation continues to strengthen, it’s very strange that the FED remains hesitant on raising rates. This is probably due to the fact that increased rates will strengthen the dollar and increase borrowing costs making the U.S. economy less competitive on a global scale. The dollar has already appreciated almost 10% since February on the assumption that the FED will raise rates soon.


As Europe and Japan continue with their loose monetary policies, it’s difficult for the U.S. to increase rates without compromising the achieved moderate economic growth. Small rate increases strengthen the dollar which increases imports and lowers exports, consequently impacting manufacturing, GDP, and finally, spending. Before accusing the FED of not taking action, it’s good to contemplate everything outlined above.

source : investing