If you’ve had any exposure to the financial media, you are aware of its continuous and obsessive speculation as to when the Fed’s well-telegraphed, quarter-point interest hike will occur.
Initially, the consensus opinion was January of this year. Now, since seven or eight months have rolled by, the debate is focused on a move in September or December. The breathless conjecture is all part of what the media likes to describe as a “rising-interest rate environment.” We, on the other hand, call it an illusion.
Fed fighting a phantom enemy
We understand the Fed is anxious to normalize interest rates, as short-term rates have been at zero since 2006, but this is not the ideal economic environment to accommodate such a move.
U.S. economic growth is anemic. Agricultural commodity prices are in the doldrums. Oil and gold are struggling at multi-year lows and although the Administration likes to crow about the low unemployment rate, there has been no perceptible increase in wages. China’s economy, which has provided our industry with ready consumption, is beginning to implode, while its currency devaluation is making the prices of our exports increasingly expensive.
These are hardly conditions ripe for the Fed to apply the brakes.
Flattening yield curve
When trying to make sense of this scenario, consider the recent action in Treasury bonds. With the talk of Fed tightening, yields on short-term notes have ticked up while yields on 10-year Treasuries are threatening to drop below 2.00%. This puts long- and short-term notes at their narrowest spread in months. Quite simply, the yield curve is flattening.
The takeaway here is that investors aren’t worried about an overheated economy accompanied by a surge in inflation. Just the opposite: a sustained rise in short-term rates could dampen the already tepid growth we are experiencing and actually cause disinflation or deflation, leading to lower long-term rates.
Remember, the Fed can only control the shortest of interest rates. That’s contrary to the “rising-interest rate environment” myth the media is perpetuating. Long-term rates will be determined by investors’ expectations of future inflation, not the Fed.
Don’t be distracted
Ignore the talking heads. Investors still on the sidelines waiting for yields to spike will again be disappointed. Worse, they will continue to forego a steady stream of tax-free income. If the Fed moves this year, today’s 4.00% yields on high quality munis will soon be regarded as a fond memory.
Our advice is simple: Keep your eye on the ball and your interest clock ticking.