Home' Trinidad and Tobago Guardian : March 22nd 2015 Contents MARCH 22 • 2015 www.guardian.co.tt SUNDAY BUSINESS GUARDIAN
FINANCE | SBG15
For want of a nail, a battle
was lost, the saying goes.
For want of a single
word, the long era of
easy money in America
seems to be drawing to
a close. That could have
profound effects, in the
long term, on the economy and the mar-
In its statement on March 18, the Federal
Reserve no longer said that it would be
"patient" about tightening monetary policy.
At the same time, however, it reduced its
forecast for economic growth and lowered
its expected trajectory for interest rates.
Investors took all this as a sign that rates
would rise later this year, albeit not as early
as some had expected. If the Fed does push
up rates, it will be the first such change
since 2006. The last rate-tightening cycle
began in 2004, when Barack Obama was
only an Illinois state senator and Twitter
had yet to be invented.
The Fed is hardly responding to an immi-
nent inflationary threat: Prices fell by 0.1
per cent in the year to January, thanks largely
to the plunging cost of energy. Unemploy-
ment has fallen to a seven-year low of 5.5
per cent, however. That may be close to the
point at which competition for labour drives
up wages, although there is little sign of
Fed chairwoman Janet Yellen was at pains
to reassure markets that the Fed would not
act intemperately. Traders on the Chicago
futures market expect its benchmark rate
to be between 0.5 per cent and 0.75 per
cent by the end of the year, up from between
zero per cent and 0.25 per cent now.
The Fed s guarded approach and careful
signaling should cushion the impact on the
markets. In most of the past seven rate-
hiking cycles, American equities wobbled a
bit around the time of the announcement
- but, six months after the first increase,
the stock market was higher than it had
been before the Fed took action.
The fear is that this time might be dif-
ferent. Central banks support for markets
since 2008 has been unprecedented, not
only in near-zero rates, but also in the buying
of assets through quantitative easing. Ana-
lysts at Societe Generale, a French bank,
point out that there have been only two
periods in which American stocks rose as
quickly in six years as they have done since
2009. In both cases, between 1923 and 1929
and between 1993 and 1999, a bear market quickly
Ray Dalio, a hedge-fund manager at Bridgewater
Associates, expressed his concerns in a note to clients,
comparing current conditions to 1937, when Fed
tightening not only caused a stock-market plunge
but also sent the American economy back into reces-
"We don t know---nor does the Fed know---exactly
how much tightening will knock over the apple cart,"
Dalio wrote. "What we do hope the Fed knows, which
we don t know, is how exactly it will fix things if it
knocks it over."
The stronger dollar may be the most significant
adverse consequence of tightening for the stock mar-
ket. American exports will be less competitive in
international markets, and the foreign earnings of
multinationals will be worth less in dollar terms.
According to Deutsche Bank 40 per cent of the profits
of companies in the S&P 500 index come from abroad,
along with a third of their sales.
Only a quarter of all profits are denominated in
a foreign currency, however, meaning that a 10 per
cent rise in the greenback cuts profits by 2.5 per cent.
Given the dollar s rise, and the impact of low oil
prices on energy firms profits, Deutsche Bank thinks
that the aggregate profits of S&P 500 companies will
be no higher this year than last. Worries about the
impact of the higher dollar on profits were weighing
on the American equity market before the Fed state-
ment, but its cautious tone sent shares rising again,
back toward the record highs the S&P 500 hit in
Bonds also rallied slightly at the apparent delay to
higher rates, which usually are bad news for the bond
market. It so far has been fairly resilient in the face
of likely Fed tightening. The 10-year Treasury-bond
yield was 2.03 per cent on March 18, below its level
at the start of the year. Even though that yield is low
by historic standards, it looks attractive compared
with European equivalents: German 10-year bonds
yield 0.2 per cent and even Italian bonds of the same
maturity yield only 1.35 per cent.
As long as the European Central Bank is buying
government bonds in its own quantitative-easing
program, those yields are likely to stay low. That
probably will keep the lid on Treasury yields, too,
since income-seeking investors will be tempted to
switch their money from Europe to America. The
coming period may resemble 2004-2005, when Fed
chairman Alan Greenspan talked of the "conundrum"
that long-term bond yields stayed low even as short-
term rates rose.
The Fed s last cycle of rate hikes eventually brought
down the housing market, triggering the financial
crisis. Homebuyers with variable-rate mortgages may
feel the squeeze this time, but many Americans have
borrowed at fixed rates. It may thus take awhile before
higher rates take a big bite out of household finances.
Mortgage payments currently comprise 18 per cent
of household income, compared with 28 per cent in
2006. Morgan Stanley calculates that rates would
have to go up by more than two percentage points
to raise the ratio of mortgage payments to income
above the long-term average.
Such calculations are all very well, but the unob-
servable variable is confidence. How will the prospect
of higher rates affect the animal spirits of investors
and homebuyers? It is nine years since the last rate
hike. Any change is a leap in the dark.
@2015 The Economist Newspaper Ltd. Distrib-
uted by the New York Times Syndicate
Monetary policy and the markets:
A leap in the dark
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