“Navigating by the stars can sound straightforward,” said Powell. “Guiding
policy by the stars in practice, however, has been quite challenging of
late because our best assessments of the location of the stars have been
changing significantly.” These are candid words for a central banker
(heaven forbid they ever communicate in plain English).
But Powell was very clear here: The stars are inexplicably shifting. For
example, estimates of the natural rate of unemployment have fallen sharply
as unemployment has tumbled, while estimates of the potential growth rate
have also plunged. He goes on: “The FOMC has been navigating between the
shoals of overheating and premature tightening with only a hazy view of
what seem to be shifting navigational guides.” Translation? My day job is
tough. Those bloody stars won’t stop moving. The usual economic indicators
we track are no longer reliable.
All of this makes monetary policy more mystifying – and, in part,
responsible for the Fed’s constellation of misjudgments in the post-crisis
period (their forecasts have consistently missed the mark since 2008). But
the more important question is why are the stars not stable, as they have
been in the past? For us, the answer is simple: A range of forces since the
GFC has conspired to broadly bring down global growth – deleveraging, a
downshift in labor productivity growth, aging populations, a slowdown in
technological advances, and maturing urbanization in China have all played
The world is suffering from a demand problem. A general rise in savings
around the globe and more risk aversion has marked the post-2008 world.
Investment demand has fallen sharply relative to the level of available
savings around the world. The last investment boom in the U.S. took place
in the 1990s during the internet and technology revolution. Since then,
capex has tumbled. And even though the U.S. is nearly a decade into its
current expansion, the total output gain is only about 85% of what it was
during the 1990s. This is a crucial reason our investment team believes the
current cycle could last longer than many anticipate.
All of the above creates more stress and uncertainty for the Fed (not to
mention a pestering president insulting your golf game and trying to
influence monetary policy from his smartphone). But where to next? In
Powell’s speech, he reviewed other historical episodes when gauging the
level of key variables was difficult – notably the 1960s and 1970s when
monetary policy mistakes contributed to an inflation blowout.
How can the Fed prevent another misstep? Powell gave some clear signals
here too. Arguing in favor of caution on policy rates, he cited the work of
William Brainard, recommending that “when you are uncertain about the
effects of your actions, you should move conservatively.” In other words,
be extremely wary of over-tightening as policy gets near neutral levels.
The fact of the matter is that the Fed, or any other central bank on planet
earth, is in no rush to normalize policy. Structural forces will keep them
cautious for years.
How does the above translate into the outlook for bonds and other
fixed-income securities? After nearly 10 years of generally falling
interest rates, many investors have come to believe in lower-for-longer
interest rates. It wasn’t always this way. In the aftermath of 2008, many
were convinced that monetary largesse would translate into a combination of
high inflation, a plummeting U.S. dollar, and gold at stratospheric levels.
But now many assets have been bid up on a “lower forever” view. It was a
long ride down in yields, boosting the values of a wide variety of interest
rate sensitive investments in the West. Through financial alchemy and a
masterstroke of marketing genius, REITs, dividend payers, and a vast
assemblage of ETF product provided a higher and more tantalizing yield. To
be sure, our clients relished in this yield bonanza (with our Global Income
strategy posting attractive calendar year gains every year since its
inception in June 2008).
But no party lasts forever, and 2018 was particularly cruel to fixed-income
investors. But the bond market will regularly run ahead of itself. Large
and steady spikes in yields, even if they glacially drift higher over the
coming years, are not likely to be sustained.
The world, facing a deficiency of demand, will continue to require lower
rates than in the past. The key point is that the bond market will be
volatile and hostage to high debt levels and other structural headwinds
around the world. Expect big bond selloffs and regular rallies. Most will
continue to panic each time. The fault will not be in the Fed’s stars, dear
investors, but in the market’s reaction to them.
Tyler Mordy, CFA, is President and CIO of
Forstrong Global Asset Management Inc., engaged in top-down strategy, investment policy, and securities
selection. He specializes in global investment strategy and ETF trends.
This article first appeared in Forstrong’s publication
Super Trends and Tactical Views, available on the
Global Thinking blog. Used with permission. You can reach Tyler by phone at Forstrong
Global, toll-free 1-888-419-6715, or by email at
email@example.com. Follow Tyler on Twitter at
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