Lower for longer interest rates

Another Look at the Dollar: The Fed and Interest Rates

Re-posted by Matthew Lang, Lang Investment Services

July 30, 2020

One of the reasons behind the recent decline of the dollar is reportedly the fact that the Fed has largely committed to keeping rates low—the market believes—forever. Looking at the yield curve, the 30-year Treasury rates are at 1.22 percent as I write this. With rates that low, the value of the dollar would certainly take a hit if other central banks raised rates.

Another way of looking at the dollar, then, is to determine whether the Fed is likely to raise rates. We can’t look at this possibility in isolation, of course. We have to evaluate what other central banks are likely to do as well. If everyone keeps rates low, then no problem. If everyone else raises rates and the Fed doesn’t, then the dollar would face headwinds. And, of course, if the reverse is true, then the dollar would have the wind behind it.

Every central bank, including the Fed, will make its own decisions, but they all have similar constraints. If we look at those constraints, we can get a pretty good idea of which banks will be raising rates (if any) and when.

Inflation

The first constraint, and the one that makes most of the headlines, is inflation. Right now, the fear is that the governmental stimulus measures, here and abroad, will drive inflation meaningfully higher and that central banks will be forced to raise rates. In that context, even if the Fed remains committed to lower rates, then other central banks will be forced to raise theirs, bringing us back to the first sentence of this post.

The problem with this argument is that we have heard it before, multiple times, and it has always proven false. Inflation depends on an increase in demand, which we simply do not see in times of crisis. The U.S., until at least the time the COVID pandemic is resolved, will not see meaningful inflation. Other countries, while less affected by COVID, have their own problems, and inflation is not likely to be a problem there either. Neither the Fed nor other central banks will be raising rates in any meaningful way. The argument fails. No problem.

The employment mandate

The second constraint, and one that is underappreciated, is that central banks have a responsibility to keep the economy going. Here in the U.S., that responsibility is expressed as the employment mandate. The Fed is explicitly tasked with keeping employment as high as possible without generating inflation. Raising rates will act as a headwind on employment. So, in the absence of inflation, the Fed has no need to raise rates. With employment not expected to recover for the next couple of years, again no problem with lower rates.

Other countries have the same issues, with the same results. Inflation is low and steady in all major economies, and unemployment is high in the aftermath of the global pandemic. For at least the next year and more, none of the central banks will face any pressure to raise rates—in fact, quite the reverse.

Lower for longer

The Fed will not be the only one holding rates low. The Fed has a press conference this afternoon where it is expected to repeat the “lower for longer” mantra. Other central banks are doing the same thing. Right now, the economy needs the support, and inflation is not a problem.

One question I have gotten is whether the Fed will implement some form of yield curve control and what that will mean for investors. Whether the Fed makes it explicit or not, I would argue that control is what we already have, and we have seen most of the effects already. Lower for longer has supported financial markets, and it will likely keep doing so. The Fed does not need to make it explicit, since it is doing so already.

Governmental finances

Looking beyond monetary policy and macroeconomics, there is another reason rates will likely remain low, which is that governmental finances will blow up if rates rise. At meaningfully higher rates, governments will simply not be able to pay their accumulated debt. All central banks are aware of this outcome, even if they do not talk about it. As far as the Fed is concerned, I suspect that not blowing up the government’s finances comes under the heading of maintaining maximum employment. It’s not an explicit objective, but it is a necessary one.

The wait for growth to return

Until we get growth, we will not get inflation. Without inflation, we will not get higher rates. With the U.S. likely to be ahead of the growth curve, as it has always been, the Fed will likely be the first to raise rates, not the last, with a consequent tailwind to the dollar’s value. Wait for growth to return, and we can have this discussion then.

That will not be soon though.

Matthew Lang is a financial advisor located at 236 N Washington St, Monument, CO 80132. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 719-481-0887 or at matt@langinvestmentservices.com.

© 2020 Commonwealth Financial Network®

Stock market ebb and flow

The worries on the market ebb and flow like the tides.

Last autumn, the worries were in full force: are we nearing a recession, is inflation coming, is this the big market correction, will the trade war escalate, will we have a lasting government shutdown, and many more.  Consequently, the market had a big drop in Q4 of last year, bottoming on Dec 24 with a drop of about 20% in 3 months.  Ouch.

Then something remarkable happened.  The worries all seemed to go away.  And just like that, the market has bounced back entirely and is right now butting up against the all-time high levels.

So what happened?  Nothing. The worries which existed in Q4 still exist.  In actuality these worries plus a myriad of other worries are always present.  The worries represent the balance of risk, which is essential in a functioning market.

I remember when I was a 25 year old advisor in 1999 at the peak of the tech bubble (we didn’t know it was a bubble then however) hardly anyone was worried, including myself.  “This is the new, connected world….a new economy,” was what everyone was saying.  And my least favorite expression of all, which I still hear on the financial news is, “we are in a goldilocks economy.”  I know what the talking heads are trying to say; the economy is neither too hot or too cold…just right; but personally I think they should find an example that doesn’t have bears in it.  More to my point, in 1999 the worries were gone, but the underlying risks were as high as ever.  The second chapter of the Goldilocks should have been published in 2000 with the bears chasing down a terrified Goldilocks and getting even.

The current worry list has some of the same entries as Q4 last year, minus a few that are resolved and plus a few new ones.  I’m happy the worries are there.  I’m happy the market risk is balanced.  I’ll be worried when everyone else is not.  I’m not worried about rain while its raining, I’m worried about rain while its sunny.

We’ve enjoyed a 2019 rally (bouncing off the 2018 swoon) and the market is probably due for a breather in the short term.  However, I think this will continue to be a good year in the market overall.  Instead of looking at the worries, I look at the reality.  We have a great economy, everyone who wants a job has one, low inflation, low interest rates, people are spending money, business is expanding, capital expenditures are up, and people are generally happy.

Spring is in the air.  In Colorado we are having our first 70 degree days this week.  Enjoy this time of year…..and leave the worrying about your money to me!

 

Matthew Lang is a financial advisor located at 236 N Washington St, Monument, CO 80132. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 719-481-0887 or at matt@langinvestmentservices.com.

Trade War

Is It Time to Worry About a Trade War?

On March 1, 2018, President Trump announced that the U.S. plans to impose tariffs on steel and aluminum imports. Markets around the world were shocked by the news, with major U.S. indices declining more than 1 percent just when it looked like they were recovering from the February downturn. Why did markets react so strongly? Is this a more serious threat going forward? In a word, yes.

First, let’s define what’s going on and why it matters.

A closer look at tariffs

The good. Tariffs are a charge on imports—essentially, a tax. Say a ton of steel costs $100. The 25-percent tariff Trump proposed would require the seller to pay $25 to the U.S. government. That would, in effect, mean the seller has to choose between selling the steel for $75, raising the price to $125 to net the same amount, or doing something in between. Practically, sellers will raise prices. This is the desired outcome, as it will allow producers here in the U.S. to sell their products for higher prices. Therefore, these tariffs are good for the steel and aluminum industries.

The bad. The problem is that they are bad for anyone else that uses steel or aluminum, such as car manufacturers, builders, and the energy industry. Their input costs have just gone up substantially. According to a UBS analyst, Ford’s costs just went up by $300 million, while GM’s went up by $200 million. Other companies will be similarly affected.

Companies like Ford and GM will have two choices here:

  1. They can raise prices, which will start to push up inflation; or
  2. They can eat the higher costs and make less money.

Either way, this is bad for the stock market, as it plays out across the economy. Both higher inflation and lower profits make stocks worth less—hence, the market reactions around the world.

Waiting for the world to react

These are only the first-order effects, of course. The next shoe to drop will be how other countries respond. If we are lucky, they will take legal action through multilateral bodies such as the World Trade Organization, which will result in negotiations. If we are unlucky, they will start imposing retaliatory tariffs of their own, targeted to cause maximum pain to the U.S. economy. We don’t know what those will be. But we can be quite sure they will be designed to hit the U.S. economy as hard as possible, in order to force us to remove the tariffs. This is how trade wars start, so it will be critical to watch those responses.

The next set of effects will be geopolitical. When you look at the actual sources of steel and aluminum imports, Canada tops the list. By angering and damaging our closest neighbor—at the same time as we are trying to renegotiate NAFTA—the possible damage just increases.

The net effect of the tariffs, then, will be economic damage, higher inflation, and greater geopolitical uncertainty. On the corporate side, it will be lower profits for the vast majority of companies. On the consumer side, it will be higher prices for many goods and, likely, lost jobs in export industries. That is why this issue is worth watching closely.

Pay attention, but don’t panic

That said, there is a real possibility that this is either a trial balloon or a negotiating tactic. The U.S. has tried to impose tariffs before, only to pull back as the costs became clear. Trump’s announcement is not the same as actual action. This could all pass away, particularly as the rapid market response shows very clearly the potential costs. It is too early to be overly concerned, but we should definitely pay attention.

Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict.

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 Matthew Lang is a financial advisor located at 236 N Washington St, Monument, CO 80132. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 719-481-0887 or at matt@langinvestmentservices.com.

Authored by Brad McMillan, managing principal, chief investment officer, at Commonwealth Financial Network®.

 © 2018 Commonwealth Financial Network®