There are many investors and observers who do not think the Fed ought to
raise interest rates today.
The Fed's targeted inflation measure, the core PCE deflator, stood at
1.3%, well below the 2% target. They see the fresh
sell-off in oil prices and are more concerned disinflation than
inflation. Over the past week or so, more concern has been expressed
about the sell-off in the high yield bond market.
Others are concerned about the strength of the dollar and the weakness
abroad. Some economists express concern about the lackluster
growth. Rather than accelerate as the year progressed, the economy
appears to be growing slower in H2 than it did in H1, despite the mere 0.6%
annualized expansion in Q1.
These doubts have given rise to speculation that the Fed will quickly
realize the error of its ways and reverse the ill-conceived rate cut by the end
of next year. Some argue that this is the same fate that has befallen
every other high income central bank that has lifted rates since the crisis,
including the ECB.
Surveys of investors and economists do not lend credence to such
pessimism. Perhaps one of the reasons
why the Fed has delayed hiking rates this long, even though unemployment is a
little lower than the start of the last tightening cycle (though the core PCE
deflator is also a little lower) is to feel confident that it can begin a
normalization cycle with minimal risk a one-and-done unprecedented cycle.
The Great
Graphic composed on Bloomberg shows the yield on 1, 3, 6 and 12 month US T-bills. The dramatic
increase in US bill yields reflect two
developments. The first is that following the bipartisan deal on the debt
ceiling, the US Treasury began selling more bills. This is to say that part of the rise in bill
yields is a reflection of supply considerations. There was pent up demand that could not be satisfied
before as the debt management ahead of the debt ceiling led to a dearth of
supply.
Second, the rise in bill yields also reflects
the upward pressure on US yields,
especially at the short-end of the curve as the market anticipates the Fed
hike. This is to
say that while part of the increase in yields reflects supply considerations,
there is also an expectations component.
Consider that the 12-month bill yield has risen from 20 bp in mid-October
to 68 bp today. It was up to 76 bp a week ago. Ideas that
the Fed would hike in September saw the US 1-year bill yield rise to 47 bp on
September 16, the day before the FOMC announcement. The yield on the
12-month bill seems low. The September Fed forecasts pointed to a 100 bp
hike next year. Even if it scales it back to 75 bp later today, there is
scope for the 12-month bill yield to rise
further.
The six-month T-bill is yielding 50 bp today. In mid-October
the yield as seven bp. It reached
almost 57 bp last week. The upper end of the Fed funds target range is
likely to be 50 bp today. It is nearly double what it was before
the Sept FOMC meeting. Supply considerations
or really stronger demand, perhaps
related to regulatory needs (incentives for some money markets to investment
only in government paper) and/or a safe
place to park funds leaving other risk markets, like the high yield bond market
may be dampening yields. Year-end considerations may also play a
role.
We suspect conditions may favor a return of the so-called Greenspan
Conundrum. It was to denote the situation the Fed found itself in early 2005 when the Fed was lifting
short-term interest rates, but long-term interest rates were stable to
lower. Bernanke's explanation was that some Asian countries
and oil producers had greater savings than they could absorb and were exporting
it to the US. This time, we suspect that the unorthodox easing in some large countries and regions, the low oil
prices, the modest growth and low inflation (even if not quite this low) may
keep long-term yields relatively low in the face of Fed tightening.
Disclaimer
Great Graphic: US Bill Yields and Fed Hikes
Reviewed by Marc Chandler
on
December 16, 2015
Rating: