Awaiting a Positive Economic Shock

Last week, I attended a ‘first annual’ Wealth and Asset Management research conference held at Washington University’s Olin School of Business.

The basic idea behind the event was to connect top tier academics with local practitioners, which seems obvious given Wash U’s stature and the fact that St. Louis has more people working in financial services than any other city outside of the big apple.

I was drawn by presentations by top academics like Toby Moskowitz, from Yale and Robert Novy-Marx, who have both been mentioned in previous Daily Insights (here and here).

As much as I enjoyed Moskowitz, Novy-Marx and the other presenters, I was surprised by how much I liked hearing from St. Louis Federal Reserve President Jim Bullard.

Actually, during a panel discussion of local practitioners just before his speech, he asked a great question of the group as an audience member.  ‘Hi, Jim Bullard, St. Louis Fed.  How are your clients reacting to negative interest rates around the world?’

The short answer from the panel was that everybody hates it, but at least it’s somewhere else.  More importantly, though, several of the panel members said that they were advising that clients pull less money from their portfolios.

When Bullard spoke, he addressed that point, saying that none of the Fed models take into consideration that lower interest rates reduce consumption.  Of course they consider it anecdotally, but there isn’t enough research on the magnitude of the issue.

The central thrust of his presentation, though, was that he thinks that low interest rates are here to stay for some time.

He’s not quite in the ‘secular stagnation’ camp like Larry Summers, who sees low growth and interest rates indefinitely; but he does say that we are in a low interest rate regime and can’t see how it changes, especially anytime soon.

This ‘regime’ concept largely explains his errant dot plots, a subject that we covered back in June, which you can find here.

The dot plot, as seen below, shows where FOMC members think rates will be in 2017, 2018 and over the unspecified ‘longer term.’

As you can see, they all see rates going up, although it’s harder to read the numbers which say between 1.25-2.5 percent in 2017, between 2.25-3.75 percent in 2018 and between 2.75 and 3.75 percent over the longer run.

And then there’s Bullard at the very bottom, who thinks that rates will stay well below one percent this year and next and is notably missing a forecast for the longer run.

2016-08-22 DI Chart 1

Although he obviously covered the topic in much greater detail in person, he basically said that everyone, in and out of the Fed, has a basic belief that interest rates should hover around the long-term average rate and he’s done with that concept at this point.

Rather than anchoring to a long-term average, he’s taking the view at this point that the economy and rates will remain stagnate until something happens and changes with the regime.

He can’t say what that ‘something’ may be, for the same reason that none of us can predict the future.  The Fed has clearly lost some of its credibility in recent years by predicting higher rates for such a long time and keeping them so low, so I thought his candor about unpredictability and uncertainty refreshing.

From a rates perspective, Bullard made the case that policy is regime dependent and that the current regime, where unemployment and inflation are near their targets (a forthcoming Daily Insights topic), rates should stay low, around 0.63 percent by his calculations.

You can find the PowerPoint presentation here, although it’s tough to follow without his commentary in my opinion.  He apparently gave a speech in London on the same topic, and while I only skimmed it, you can read it here if you want more details.

Ultimately, as much as I liked his presentation, my conclusion was that the Fed is simply catching up with what the market has been thinking for some time.  I’m glad about that, but at this point, he’s just one member (although the news about the San Fran Fed seems similar at this point).

Now all we have to do is cross our fingers that the next economic shock will be a positive one.