Have you ever said something, and meant it, but decided afterwards that perhaps you could have phrased it a little differently? Of course you have. We all have. New Fed Chair Janet Yellen certainly made a splash in her inaugural press conference this week. She said something very interesting that really moved markets. The seasoned and accomplished economist provided more specificity regarding the future of interest rates than expected. When asked how long we should expect the first rate hike to occur after quantitative easing (QE) ends, she said approximately 6 months. Both stocks and bonds immediately fell, while interest rates jumped.
But what did she really say? QE, which has consisted of the Federal Reserve Bank purchasing Treasuries and Mortgage Backed Securities for years, is slated to come to a close towards the end of the year, say November. The taper will be done. 6 months later will be May of 2015. So the Market took it that rate hikes are coming in about a year, which is earlier than consensus thinking of the end of 2015.
That’s actually a good thing. It means the Fed is telling us the economy has improved, and is capable of functioning on its own without aid. That’s very healthy. Janet Yellen did a real service for investors. The Market has officially begun preparation for higher interest rates, and is discounting the need for Fed dependence. Should the economy reverse course and decline, we are confident that a Yellen- led Fed will provide more stimulus. Technology and Financials tend to do well in a rising rate environment. It’s the next stage for this Bull Market, and it will be bumpy.
Digging deeper, there’s an interesting dynamic going on with interest rates (well, interesting for us Market folk I suppose…). Short-term interest rates jumped this week off the Yellen commentary, but longer-term rates barely budged. This is called a flattening of the yield curve. Rising rates are a risk for the economy because it means the price of money gets more expensive. However, the 30-Year Treasury yield is actually lower today than it was a month ago, while the 3-Year, 5-Year and 10-Year yields are all higher. The importance here is that mortgages are generally tied to the 30-Year Treasury, so mortgage rates remain quite low which is critical for housing and housing is key to the US economy.
Taking it a step further, we’ve seen a significant reversal in agriculture and commodity prices. After 3 years of declines, the last 30 days have seen price increases for sugar, coffee, soybeans, and cattle among others. This is traditionally a good proxy for global demand, which appears to be strengthening. The rest of the world, particularly Asia, might finally begin playing catch-up to the US. Emerging Markets have been lagging big time. A change could be in the offing. This has major investment implications, and we are studying closely.
Enjoy the weekend. March Madness is upon us. Research is our game. We’ll be back dark and early Monday.
By: Mike Frazier