Fed and Interest rates.

August 23, 2012August 23, 2012 Hamilton

This is the HQ for the Federal Reserve System. The (Eccles) building speaks for itself, it is pretty austere and not particularly welcoming. There is absolutely no imagination here. The Chair receives $199.700 per year, all other members about $20,000 less. The Fed is a private corporation, owned by a limited number of shareholders (like JP Morgan), who receive a statutory dividend of 6% of invested capital.

From the most recent meeting;

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects economic growth to remain moderate over coming quarters and then to pick up very gradually. Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate.

The dual mandate consists of maximum employment and stable prices. As you can see from the above “growth” is viewed as being synonymous with employment at least from a policy action point of view. We know that the stock market is also directly targeted. The Fed is therefore basically responsible for prosperity and the continuation of the American dream. Essentially an impossible task, full of contradictions, which makes it all the more amazing that the general public actually believes that they will succeed while at the same time expressing their unwavering believe in the free-market capitalism. To add to this, there is no body of economic science that has been tried and found sufficiently true enough to be reliable to use as a guide. Decisions are accordingly made for the most part using the wet-finger method. Fed speak, if the truth be known, is not so much a deliberate attempt to obfuscate as it is simple the result of genuine groping in the dark. Read the entire minutes!

So QE3 is on it’s way, and just to help, China’s Central Bank also “injected” more liquidity. Will it work? Presumable “work” in this context would imply lower rates in the near future. Here is the US Gov. 10-year chart;

For longer term reference we have added the St. Louis Fed’s 10 year constant maturity chart. The high was slightly above 15% and the low at 1.39%. Both , by the way , violate another mandate that the Fed. has, which is to keep interest rates at moderate levels, which can hardly be said for either Volcker or Greenspan/Bernanke rates. If you look at the 10 year chart you will see that interest rates actually rose by almost half a percent since July, which does not surprise us considering our expectation of a low back in June (June 7 under “interest rates”). BUT, because the chart has the unmistakeable signature of a diagonal, we have to keep an open mind at least to the possibility of another, brief, low extreme. Wave 2 and 4 touch at 2.4% and for the past 10+ months interest rates haven’t done anything. A drop to the trend-line is still a possibility. Rates could reach about 1.1%. It is not something you want to trade on. After a new low, should it even occur, a fairly violent rise to 4% for starters should be expected thereafter.

Interest rates. Update.

June 7, 2012June 7, 2012 Hamilton

This is the one year T-bill rate in the US, courtesy St. Louis Fed. In a previous blog (March 19, 2012) I had commented how, frequently, markets have a predilection for symmetry, perhaps it strokes our sense of aesthetics the right way, whatever. In this chart I have endeavoured to “show” what symmetry would imply, and remember a picture is worth a thousand words.

We know that interest rates hit a low immediately after WW2, I believe in 1947. This chart does not go back quite that far but it is easy to imagine where that point is. The two, thick purple lines are drawn vector equal but opposite in direction. What it tells us is that rates are about to reverse any time now, probable before this year is out. This is not that big an insight as you cannot really go below zero, not if you are running trillion dollar deficits year after year.

What may not be that obvious is that market action near peaks or lows can become decidedly unnerving. During 1980 US rates went up and down by about 8% in a matter of months. Jimmy Carter was president and we had the Iranian hostage crises that occupied most of the news. There was talk about limiting the use of credit cards etc.etc. It was great for traders if you got it right (I did for the most part for my bank Conti. Ill.) but no fun if you did not. Carter did not get re-elected and the hostages were released the day after Ronald Reagan became president.

In a previous blog (by the same name) I had assumed t to be 34 years, somewhere between 32 and 33 is probable more correct. 32 would take us to 2011 and 33 to 2013. In practical terms that is now.

Interest Rates.

March 19, 2012March 19, 2012 Hamilton

See also Keynes in a previous blog. This fellow believed that the best rate for interest rates would be zero, which thought process seems to have been adopted entirely by Bernanke. Others, more correctly, believe that capital is just another economic input that has its own price, essentially where the pain of delaying gratification equals the joy of immediate consumption. No one knows where that equilibrium is at any point in time but history would suggest that it is above 2% in real terms, so about 4.5% Given that taxes take a big bite out of the return perhaps the equilibrium level should be a few percentage points higher, somewhere between 6/7% seems reasonable.

The notion that the Fed. actually controls interest rates has taken hold over the past few years despite evidence to the contrary. Remember the “conundrum” that we had a few years ago and now again, in the midst of operation twist long rates are actually going up not down. In truth it probable was only possible to have such low rates thanks to first Japan and later China, both of which had sound economic reasons to “sacrifice” return for exchange rate and trade advantage. So, for the sake of argument, assuming that the Fed cannot control interest rates, when might they start going up?

Charts are hard to come by but here is one of the US Fed. Funds rate, basically call money:

We know that the lows in interest rates came about a little after the second WW, say 1947. This was a time when all concerned would have wanted low rates simple to rebuild. Often, for reasons I do not understand, markets just love symmetry. Applied here one would expect that the period from 1947 to 1981, thirty-four years, would be repeated on the other side which would bring us to 1981 + 34 = 2015 give or take a year.

Using short-term (one year?) rates from the Bank of Canada (unfortunately I could not find a single chart) we get similar results. Low rates (1%) prevailed from 1947 to 1951. Let’s assume that the low was right in the middle, that is in 1949. It would then take 32 years to get to the highs of 1981, so in order to achieve perfect symmetry one should aim for 2013 for rates to turn, again give or take a year. Last year, to almost everyone’s surprise, long bonds were by far the best investment class to be in with an overall return somewhere in the order of 35%. Next year may repeat that performance, but chances are equally good that it will turn out to be the worst asset class. By the way, higher rates would be good for a lot of different investors, but initially as rates start to go up the process can be double painful.

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