Does Fed chair Janet Yellen know something investors don’t? Photo by Chip Somodevilla/Getty Images.
“It could happen sooner than markets currently expect,” said BOE governor Mark Carney regarding a possible short-term interest rate hike at a big speech last Thursday, sending rate speculators and central bank watchers into overdrive. Out are bets made on earlier forward guidance of a 2015/16 hike; in are new guesses a hike will come as early as this fall. The US version of this—fed funds hike speculation, including semantic analysis and word choice dissection, will likely commence later this week after Fed Chair Janet Yellen meets the press following the Federal Open Market Committee (FOMC) meeting. In our view, however, trying to forecast when a rate hike will come is attempting to game the ungameable in an effort to uncover actions history shows aren’t very consequential for stocks. This is largely noise for investors.
Following Carney’s announcement, the British pound surged relative to the dollar (currencies often chase higher rates), short-term interest rate futures for 2015 jumped by 20 basis points, and commentators speculated about the timing of the first hike—some pegged it around Christmas 2014. Some a bit earlier. Some a bit later. In Carney’s wake, debate about whether Yellen would follow suit began. While some believe the Fed won’t “roil the waters” since the US economy isn’t quite at the same stage as the UK’s yet (sketchy analysis at best), others aren’t so sure. One group of experts went so far as to devise a tool to help, blending economic indicators historically favored by the Fed head into a so-called “Yellen Index.” The present read suggests a US rate hike is nigh.
Yet all this clucking seems a bit misguided. Trying to game the Fed’s next move based on Yellen’s past preferences overlooks a few inconvenient facts, like Martin’s little pill. Once they’re in the top spot, Fed heads tend to act differently than their resume would seemingly indicate. Though a new chair enters the position with a long history and well-known preferences, the Fed’s actions don’t always match precedent. Building an index (the Fed Head 500?) that draws from past transcripts, interviews and academic papers won’t necessarily reflect a central banker’s current thinking, interpretation of data or shifting preferences. Perhaps more importantly, it doesn’t represent the thinking of the other FOMC voters at all—and interest rate decisions are made by consensus.
Plus, talk of a monetary policy move is cheap, and trying to game what’s in a dove or hawk’s head is a bit birdbrained. Central bankers have a history of revising projections if reality doesn’t match their forecasts. Consider: The BOE’s latest timeline shift for a rate hike isn’t the first such change. In October 2013, the BOE indicated a hike wouldn’t come until after unemployment fell to 7%, a threshold they projected the UK to hit in 2016. Yet Carney had to recant that as the UK recovery accelerated. As of last month, UK unemployment was at 6.6%. Yellen has parroted Carney’s penchant for backtracking on specific unemployment rate targets as well. The Fed has continually chirped that they wouldn’t consider hiking short-term interest rates until unemployment fell to around 6.5%. However, in March the Fed apparently decided this was too hard and fast and dropped this target altogether, opting for the squishier “range of data” threshold. (For the record, both April and May showed an unemployment rate of 6.3%). The range of data statement led many to scrutinize FOMC member forecasts for rates—the so-called “dot plot.” However, these too are just guesses, and Yellen has been quick to remind folks the dot plot of forecasts is a living, breathing thing. (Well, not literally living and breathing. It’s just subject to error and change. However, we’re fairly confident the forecasters are literally living, breathing things.)
All this may seem less than optimal, because it’s not as transparent, something Yellen’s predecessor Ben Bernanke claimed was desirable.[i] In our view, central bank–speak should in general be, well, general. If central bank chiefs are ultra-specific, investors could try and front run them, which could limit their ability to influence interest rates and inflation. Too much specificity could also set expectations that may not be met, creating more uncertainty, not less. Yellen experienced a little taste of this firsthand after her first meeting as Fed chair. When asked to clarify what constituted a “considerable time” between the end of quantitative easing and the first rate hike, Yellen answered, “around six months or that type of thing,” causing markets to wiggle in the short term. “Keep’em Guessing” Carney has this aspect of vague forward guidance somewhat right, in our view.
All in all, the guessing game of trying to forecast rate moves is typically based on the fallacious view rate hikes are generally bad for stocks. History has shown initial rate hikes don’t roil markets—markets saw positive returns over the year following six of the past nine initial rate hikes. Think about it: The Fed typically hikes rates when inflationary pressures are rising, which tends to be coupled with economic growth. This doesn’t make rate hikes bullish—stocks just rise more than they fall—but fears one could derail this bull seem unfounded. In our view, we would humbly suggest time is a very valuable commodity for investors, and it’s one better spent analyzing market functions rather than banker wordplay.
[i] There is very little way to argue the haphazard actions of the Bernanke Fed in 2008 were “transparent.”