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Interest Rate Behavior and
Misbehavior Post-Financial Crisis
Joe El Rady
FED TAPERING WILL NOT RAISE
INTEREST RATES
QE has raised rates while tapering has
lowered them
Source: STA Wealth
QE and ZIRP by design support risk
taking
• QE and ZIRP redirect capital from bond markets
to risk markets.
• Conversely, ...
TAPERING MAY LEAD TO ECONOMIC
WEAKNESS
Without Fed support the economy has
weakened
Source: STA Wealth
Economic weakness in the absence of
Fed support has lowered interest rates
• Each time the Fed has withdrawn financial
acc...
US economy already has enjoyed 7th
longest expansion since 1879
The end of QE / ZIRP may end this
already long expansion
• The Federal Reserve’s programs have
effectively and successfull...
The expansion, though long, has been
frail
• US economy has not grown as robustly as it
should during the first few years ...
Real GDP growth lagged over the past
several years compared to other cycles
Inventory buildup has lagged and
productivity growth has been weak
Personal consumption growth has
been dismal
Retail sales collapsed during
recession…
… and continue to underperform their
long term trend…
…especially when adjusted for inflation
and population growth
Comparison to other recessions
demonstrates the weakness in retail…
…arrested by low personal income
levels starving the economy of fuel…
…and hindering personal credit
growth…
…lagging confidence…
…due to low job growth feeding a
cycle leading to lower job growth
The growth that has occurred in jobs is
not only anemic, but also sub-standard
• Almost 70% of jobs created in Q2 2013 and...
THE LIQUIDITY TRAP RENDERS
MONETARY POLICY INEFFECTIVE
The Fed may also be caught in a Japan
style liquidity trap
• Cheaper credit through monetary easing
doesn’t yield much whe...
Twenty years of low interest rates in
Japan has failed to sustain growth
MARKET DYNAMICS MAY
CONTINUE TO COMPRESS RATES
As long as the world remains awash in
liquidity, Treasuries will rally
• Higher propensity to save in emerging
economies, ...
Supply and demand dynamics also
contribute to the rally
• Higher levels of treasury purchases are
occurring while the supp...
PRICE AND WAGE DISINFLATION
WILL KEEP RATES LOW
With inflation below target, rates will
not rise
Labor costs remain essentially flat
Inflation is a rise in the price level
• Prices = Supply of Money * Velocity of Money
• Regardless of how much the Fed inc...
Money hoarding has offset money
supply
PREDICTIONS AND CAUTIONS
Predictions
• Expect the size of the Fed’s balance sheet to
remain above 2011 levels until 2020.
– The Fed has stated that...
Cautions
• The aging demographic will continue to strain
the financial system, increasing levels of
indebtedness and poor ...
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El rady interest rate forecast

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El rady interest rate forecast

  1. 1. Interest Rate Behavior and Misbehavior Post-Financial Crisis Joe El Rady
  2. 2. FED TAPERING WILL NOT RAISE INTEREST RATES
  3. 3. QE has raised rates while tapering has lowered them Source: STA Wealth
  4. 4. QE and ZIRP by design support risk taking • QE and ZIRP redirect capital from bond markets to risk markets. • Conversely, recent tapers have reversed capital flows from risk assets to the safety of the bond market, raising bond prices, which lowers bond yields. • Therefore, further Fed tightening will likely lower interest rates again as investors flee to safety, increasing demand for bonds, which raises their prices and lowers their yields.
  5. 5. TAPERING MAY LEAD TO ECONOMIC WEAKNESS
  6. 6. Without Fed support the economy has weakened Source: STA Wealth
  7. 7. Economic weakness in the absence of Fed support has lowered interest rates • Each time the Fed has withdrawn financial accommodation, the economy has flagged pushing interest rates lower. • Without Fed support, continuation of an already long economic expansion will prove difficult given the lack of underlying drivers that contribute to growth.
  8. 8. US economy already has enjoyed 7th longest expansion since 1879
  9. 9. The end of QE / ZIRP may end this already long expansion • The Federal Reserve’s programs have effectively and successfully pulled forward future consumption to support current GDP. • The end of these programs may reveal the void. • Even small increases in interest rates can immediately dampen interest rate sensitive economic activities such as business lending and real estate purchasing.
  10. 10. The expansion, though long, has been frail • US economy has not grown as robustly as it should during the first few years of a post- recession recovery. • Reduced average household incomes (which have actually fallen every year for the past 5 years on an inflation-adjusted basis) have restrained the recovery.
  11. 11. Real GDP growth lagged over the past several years compared to other cycles
  12. 12. Inventory buildup has lagged and productivity growth has been weak
  13. 13. Personal consumption growth has been dismal
  14. 14. Retail sales collapsed during recession…
  15. 15. … and continue to underperform their long term trend…
  16. 16. …especially when adjusted for inflation and population growth
  17. 17. Comparison to other recessions demonstrates the weakness in retail…
  18. 18. …arrested by low personal income levels starving the economy of fuel…
  19. 19. …and hindering personal credit growth…
  20. 20. …lagging confidence…
  21. 21. …due to low job growth feeding a cycle leading to lower job growth
  22. 22. The growth that has occurred in jobs is not only anemic, but also sub-standard • Almost 70% of jobs created in Q2 2013 and 60% of all jobs in the first half of 2013 were created in the three lowest-wage sub-sectors: – Walmart, McDonalds, Janitorial etc. – These jobs pay an average of only $15.80/hour – Half of these jobs are part-time
  23. 23. THE LIQUIDITY TRAP RENDERS MONETARY POLICY INEFFECTIVE
  24. 24. The Fed may also be caught in a Japan style liquidity trap • Cheaper credit through monetary easing doesn’t yield much when cheap capital is already abundant. • For example…
  25. 25. Twenty years of low interest rates in Japan has failed to sustain growth
  26. 26. MARKET DYNAMICS MAY CONTINUE TO COMPRESS RATES
  27. 27. As long as the world remains awash in liquidity, Treasuries will rally • Higher propensity to save in emerging economies, coupled with investor preference for safety, has increased worldwide demand for bonds. • Foreign central banks, such as China’s, are buying US Treasuries in order to gather dollars, thereby weakening their own currencies in order to boost exports. • Financial institutions are also increasing Treasury purchases to satisfy bolstered regulatory capital requirements.
  28. 28. Supply and demand dynamics also contribute to the rally • Higher levels of treasury purchases are occurring while the supply of you US government debt continues to shrink due to a lower budget deficit. • The US government has enjoyed increased tax receipts due to higher tax rates, leading to lower levels of Treasury offerings.
  29. 29. PRICE AND WAGE DISINFLATION WILL KEEP RATES LOW
  30. 30. With inflation below target, rates will not rise
  31. 31. Labor costs remain essentially flat
  32. 32. Inflation is a rise in the price level • Prices = Supply of Money * Velocity of Money • Regardless of how much the Fed increases the supply of money, the lack of movement (velocity) of that money, will offset the supply, preventing an increase in the price level.
  33. 33. Money hoarding has offset money supply
  34. 34. PREDICTIONS AND CAUTIONS
  35. 35. Predictions • Expect the size of the Fed’s balance sheet to remain above 2011 levels until 2020. – The Fed has stated that it has some tolerance for a period of inflation in excess of its long-term targets. • Expect policy rates close to zero until about 2016.
  36. 36. Cautions • The aging demographic will continue to strain the financial system, increasing levels of indebtedness and poor fiscal policy to combat the issues restraining economic growth. • Therefore, continued monetary interventions may create the next boom/bust cycle in financial assets. • A potential for phantom inflation caused by bubble in asset prices remains a serious risk.

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