Federal Reserve Chair Janet Yellen made some interesting comments Wednesday when she announced the raising of interest rates another 25 basis points. The new target range is 1 percent to 1.25 percent, and the current rate is 0.91 percent. Yellen stated that the Federal Reserve would begin its exit from the $4.5 trillion in bonds on its artificially inflated balance sheet. She indicated this exit would be “gradual” and “predictable.”
I, for one, agree with her. I think it is something we have needed to see for some time. If it is, in fact, a gradual exit, it could have little negative impact on the economy and the markets in the short term. However, this also begs the question of whether the Federal Reserve is losing whatever effectiveness it’s had over the markets. By all accounts, the answer is “yes.” With the markets at all-time highs, the rise in interest rates does not appear to be cooling off Wall Street.
A Disconnect Exists
Because markets continue to be strong in a rising-interest-rate environment, many people are indicating that there seems to be a disconnect between what the Federal Reserve is saying and doing and the reaction of the markets.
While I think this is certainly the case, the question we need to ask is why that should be alarming. The reason is one that sometimes gets overlooked—the influence of other central banks around the world.
Central banks in Asia and in the Euro Zone are still working hard to stimulate their own economies. Their efforts to do that are stimulating the markets in the U.S. as more and more investors, sovereign wealth funds and those central banks are investing in U.S markets.
This indicates that they, too, are optimistic about the Trump agenda stimulating the U.S. economy and the corresponding impact on the markets. Like everybody, other banks and investors are searching for higher returns and better deals. America offers a golden opportunity to get in on one of the strongest economies—and the largest economy—in the world.
Snapback Effect
We have also watched another counterintuitive development. Namely, lending rates continue to drop in this rising-interest-rate environment. But what will happen when these international economies begin to recover and year-old U.S. bonds and lending rates begin to get more in line with what the Fed has been doing for the last 12 months? It will create a snapback effect that could damage our economy, and markets will drop.
There are several factors that must be considered when it comes to the ongoing uptick in our markets. One of these will be the selling of U.S. instruments by some of those foreign markets traders and central banks as they move funds back into their own economies.
Another issue that could arise comes as a result of our markets beginning to realize the growing disconnect between rising interest rates and rising markets.
Let’s not forget that when the Federal Reserve started raising rates, they were influenced by a very strong pro-growth agenda in this administration. There was also a 2.1 percent inflation rate, which was above target. When you add to the picture a tightening labor force and the reality of the current pro-growth agenda getting legs, the uncertainty rises.
The inflation rate is at 1.7 percent, and there is a possibility that hiring could once again slow as optimism begins to wane and international investors begin to sell. All this could mean a very strong and long-lasting snapback in the markets.
Reform Needed
As I look at where things stand today, I believe at their next meeting in September that the Federal Reserve governors will think long and hard before approving a third interest rate hike in 2017. Not raising rates again would exacerbate the possibility of this snapback if it’s read as the Fed losing confidence the economy.
All this is why our legislators must get tax reform done before the end of this year, retroactive to January 1. This has the ability to solve most of these potential concerns about the markets. It will help regain our focus on a thriving economy and jobs while restoring optimism on Main Street.
Some legislation, PLEASE.
(Dan Celia is president and CEO of Financial Issues Stewardship Ministries, Inc., and host of the nationally syndicated radio and television program “Financial Issues,” heard daily on more than 630 stations across the country and reaching millions of households on the National Religious Broadcasters Network, BizTV, Dove-TV and others. Visit www.financialissues.org.)