Wednesday, December 16, 2015

Rates rise, sky doesn't fall

Markets today welcomed the Fed's decision to raise short-term interest rates. It's hard to imagine how this tiny move could prove troublesome, but it's not hard to see why the market cheered. At the very least it removes the uncertainty that had surrounded the Fed's ZIRP for many years. It also sends a positive message, since it's the Fed's way of saying they have more confidence in the economy's ability to continue growing. On the margin it makes saving more attractive, and borrowing a bit less cheap (real borrowing costs have been generally low and now they're a bit less low), and there's nothing wrong with that A modest rate hike is supportive of the dollar, and a strong dollar is always preferable to a weak dollar, since it attracts capital and capital is what powers productivity.

The following charts are updated versions of some of my favorites:

The chart above shows the equity market's sensitivity to fear, uncertainty and doubt (as proxied by the ratio of the Vix to the 10-yr Treasury yield). Uncertainty has dropped meaningfully with today's Fed announcement, and that has bolstered the prices of risky assets, as it should.

The prices of gold and 5-yr TIPS (using the inverse of their real yield as a proxy for their price) continue their multi-year downtrend. I've featured this chart for years, arguing that it shows that the market is gradually becoming less risk averse (gold and TIPS are classic safe havens).

Rising real yields on TIPS are also a sign that the market is becoming more confident in the ability of the economy to grow. The market is still quite cautious (on average the real yield on 5-yr TIPS tend to be about one percentage point less than real growth, but as of today it is about two percentage points less), but on the margin becoming less so.

So, a bit of good news as we enter the holiday season.


Benjamin Cole said...

Well, nice post, but does anyone have confidence in the Fed's forecasting ability? The Fed has been over-estimating growth and inflation for years.

The Fed has other tools at its disposal, such as the size of its balance sheet, or interest on excess reserves, or its mysterious reverse repo program.

The rate move maybe in the wrong direction, but we also have to look at these other tools the Fed has.

Unfortunately the body of evidence suggests the Fed is tightening, as seen by rising dollar and sinking PCE deflator.

About two thirds of the rather minimum inflation we see (as reported) is due to housing costs.

Gadzooks, inflation is dead. As the great Winston Churchill once said, "There is no point in making the rubble bounce."

I prefer that economic prosperity be the goal of public agencies.

BTW, at the GOP debate I learned there is only one issue, and that is how afraid you are of terrorists.

Also, a candidate can make a completely sexist comment, as did Carly Fiorina, and evidently it does not matter.

I guess no one is listening to this slate of GOP candidates. I am sorry I did. And no, the Dems are no better.

Roy said...


What's going on in Argentina now sure looks familiar... how long till they default? Contagion to Brazil? etc. Thanks.

Scott Grannis said...

Roy: what's going on in Argentina is a lot of good stuff. The new President is doing what needs to be done. By liberalizing the exchange rate, capital should begin to return to the country. It's paradoxical, but when there are exchange controls and capital can't leave, it leaves anyway via a number of circuitous routes. Without exchange controls, a weaker peso (today it is about 14) will attract capital and investment. I am quite optimistic about Argentina.

Lawyer in NJ said...

Argentina's issues are too arcane for me, but in light of Scott's writing on the subject in the past, that's good to hear.


I apologize for straying off topic, but if you have any thoughts on the recent, and seemingly annual, analyst comments about Apple's supply chain, as an investor in the stock, I would love to hear them.

(If you would rather not comment, I completely understand.)

Benjamin Cole said...

10-year Treasuries up....
Like I said, the Fed cannot tighten its way to higher interest rates.

D said...

Appreciate your positive outlook, but how can "it make saving more attractive" when the banks will not raise rates for customers.

Kenneth said...

The sky didn't fall Wednesday but it sure did Thursday and Today. What do you think is the reason? My guess is that investors who have been around a long time feel that once the Fed starts to raise rates, regardless of what they say, means that growth will have a steeper slope to climb and it is only a matter of time, not if, before GDP slows and profits so why pay the same multiples for earnings as have been paying.

Kenneth said...

The sky didn't fall Wednesday but it sure did Thursday and Today. What do you think is the reason? My guess is that investors who have been around a long time feel that once the Fed starts to raise rates, regardless of what they say, means that growth will have a steeper slope to climb and it is only a matter of time, not if, before GDP slows and profits so why pay the same multiples for earnings as have been paying.

marcusbalbus said...


Hans said...

This has been nothing short of a Kardashian moment
for too many financial and economic publications and

Will they, won't they? Who is on first? This has been
the worst soap opera, since the founding of this needless

I am quite surprised that CNN did not do a two week
countdown before the BIG Yellon.

History, will not look likely upon neither the Chairperson (women)
nor the State Currency and Interest Controller.

No one within the FRB will take any blame for any future calamity
caused in part or whole by their central planning; be rest assured.

Scott Grannis said...

Diana, re saving: Perhaps some banks will not raise the rate they pay on savings deposits, but competitive forces should work against such an outcome. The Fed is trying very hard to get all short-term rates up, by engaging in reverse repo transactions with a wide range of institutions. If a money market fund, for example, can receive 0.5% on its reverse repo transactions with the Fed, it could easily pay a decent fraction of that to its investors. If it doesn't, but others do, it will lose depositors. Already, 3-mo. Libor rates are reflecting this new reality. I think there is every reason to think that short-term rates at banks and money market funds will rise generally from previous near-zero levels.

marcusbalbus said...

uhhh. beavis?

Alex in Montana said...


With defeat of the Fascist/Marxist government under the Kirchner's, Exxon just announced an investment in the Vaca Muerta shale play of up to $14 billion. Exxon waited until these klepto-leftists were gone. The new President, Macri, might also boot the huge Iranian presence in Argentina back to Tehran.

Scott Grannis said...

Kenneth: I don't think the market is worried that higher rates will threaten the outlook for growth and profits. Instead, I think the market remains very worried about the persistent weakness of commodity prices (including oil(, in the belief that these reflect already-weakened economic fundamentals (e.g., lack of demand, deflationary forces). If the economic fundamentals are weak, as the market apparently suspects, that in turn suggests that the Fed has made a mistake by initiating a tightening cycle. This I think is the prevailing consensus.

In contrast, my position for years has been that monetary policy is unable to "stimulate" the economy, and I think the evidence supports that. Years and years of zero rates and abundant bank reserves and yet the recovery has been persistently weak. That same logic suggests the raising rates won't be "restrictive." QE wasn't really about stimulating the economy, it was all about converting notes and bonds into T-bill substitutes (bank reserves) in order to satisfy the world's demand for safe assets. I think that demand has been satisfied, and so QE can be slowly unwound (it's going to be very very slow) without endangering anything.

Scott Grannis said...

Alex: great news indeed from Argentina, thanks for the links.

Roy said...


"Without exchange controls, a weaker peso (today it is about 14) will attract capital and investment. "

Without looking specifically at Argentina, my understanding is that as far as developing countries go, weaker currencies do not necessarily attract capital flows in the longer term. Capital will flow if there is confidence in the economy, and this confidence can flip awfully fast. Of course this is not hypothetical, this is how events unfolded in the previous Lat Am crisis.

So, it is required that:
1. There is indeed available global capital liquidity to flow into the developing markets.
2. Confidence in the future economy of the developing country.

Once 2 fails, with weaker currency, it means lack of foreign currency reserve and default. Hence my question about Argentina.

Hans said...

Merry Christmas to one and all!

Scott Grannis said...

Roy: You are of course correct; capital inflows require confidence. And confidence in the future of Argentina has now gone up meaningfully. As for available capital, not to worry: the supply of capital in the world is essentially limitless. Capital is now returning to Argentina, and the exchange rate has firmed marginally to 13.

Roy said...

Scott, and interest rates at 21.75%, fellow country Brazil's economy in serious situation, it just all looks so familiar. This is not the U.S. that has the institutions to handle crisis. I guess at the end it would depend on the liabilities structure of their B/S which would have higher impact than any "good intentions" at this point, but on that I have no clue other than looking at the previous' government and wondering what skeletons are hiding in there..

Thank you for a whole year of sharing your wisdom with us! Merry Christmas, Happy Holidays and a year of good health to you and your family.

Johnny Bee Dawg said...

I think the market sold off sharply the week before Christmas because of the omnibus spending bill that passed. Commodity prices weren't moving those days. It's just more proof that there's nobody to save us in Washington. Hopes of reform there keep diminishing, as establishment PUBs coddle anti-growth socialist policies of a lame duck Marxist President. Markets rally again whenever He goes on vacation. The longer, the better.