Market Pulse: The Fed and interest rates
July 23, 2014
With the recent release of minutes from the Fed's Open Market Committee and last week's testimony on Capitol Hill by Janet Yellen, we've learned a little more about the Fed's plans for interest rates. A "little more" may be a bit of a stretch.
Speaking of a stretch, Ms. Yellen made headlines when she talked about valuations being "stretched" in some sectors of the market.
She mentioned social media and biotechnology stocks. It is unusual, but not unheard of, for a Fed chairman to talk about stock valuations.
Recall Alan Greenspan's using the term "irrational expectations" years ago, a premature observation. What in Ms. Yellen's background would make her opinion of valuations for social media stocks or for that matter any others more insightful than Wall Street analysts?
Nothing. I am reminded of famous investor Bernard Baruch, who reportedly said, "No one knows if stocks are overvalued or undervalued. That's why we open the market every day." Indeed.
Back to the Fed. Two weeks ago the Fed released minutes from their previous meeting in which members discussed the gradual end (i.e. tapering) of the asset purchase program (QE).
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The program is on track to be ending in October, provided economic growth accelerates and the labor market continues to improve.
Two big "ifs" given the global uncertainties. Ending QE is one thing, raising rates another. When will rates begin to rise? Not even Janet Yellen knows for sure since much will depend on economic growth in the months ahead.
Forecasting interest rates is a humbling business. As the year began virtually everyone was certain longer-term rates would rise as the economy picked up. The economy shrank in the first quarter and rates fell.
Even after the Fed announced the tapering of bond and mortgage purchases and their ultimate end, rates initially rose a bit, then fell. Few anticipated lower rates. But that was then. What's ahead?
Longer-term rates, which reflect credit demands and inflation expectations, are far more likely to rise from here than fall as the economy improves and investors show concern about inflation.
Income investors will see better yields later in the year and into next. There will be opportunities to put money to work. Short-term rates, which are controlled by the Fed, will begin to rise as most expect by mid-year 2015.
After all, when rates are virtually zero, there is no room for them to fall. Don't fear a slow and modest rise in short-term rates. That would only occur in a growing economy, which means profits will be rising, too, and so will stocks.
On balance, good news for savers, good news for stock investors … in my humble opinion.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.ETFportfolios.net or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.
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