In her speech on March 27 at the Federal Reserve Bank in San Francisco, Ms. Yellen repeated her usual points about the Fed needing to begin normalizing the Fed Funds rate this year. She noted that the economy continues to recover; however, she did acknowledge that growth in the first quarter slowed somewhat, mainly due to the severe winter. Still, she maintained her general view of “cautious optimism.”
Yet later on in her lengthy speech in a section subtitled “Special Risks and Other Considerations” is where things got very interesting. The first of her special concerns about hiking interest rates began as follows: Some recent studies have raised the prospect that the economies of the United States and other countries will grow more slowly in the future as a result of both demographic factors and a slower pace of productivity gains from technological advances.
At an extreme, such developments could even amount to a type of ‘secular stagnation,’ in which monetary policy would need to keep real interest rates persistently quite low relative to historical norms to promote full employment and price stability, absent a highly expansive fiscal policy.” [Emphasis mine.]
To take a step back, the term “secular stagnation” is not new. It was originally coined in the late 1930s in the Great Depression era and refers to the theory that an economy may become stuck in a long-term period of slow growth, low productivity and low interest rates, due to certain external factors.
Prior to Yellen’s March 27 speech, the last time the term secular stagnation was referred to was by former White House economic adviser Larry Summers, who in late 2013 suggested that the US might be mired in secular stagnation. So what exactly is secular stagnation? [Secular stagnation is where Japan has been for most of the last 20 years.]
In secular stagnation, people become so concerned about the economy that they obsess on saving money, rather than spending it and making longer-term capital investments in such things as infrastructure, education, etc. that are necessary to sustain future economic growth.
Over time, the absence of such capital investments, and consequently of economic growth, leads to declining levels of per capita income and eventually per capita savings. Once set in place, secular stagnation can become a self-fulfilling prophecy.
In April 2014, Brown University economists Gauti Eggertsson and Neil Mehrotra published a comprehensive model of secular stagnation, showing how income inequality and a drop in population growth, both of which we have now, could lead the economy into a period of slow growth as we have seen since the current recovery began.
Essentially, the economists’ point is that a surplus of individuals looking to save their money, combined with a lack of individuals looking to borrow and spend money, can lead interest rates to fall to unusually low levels. That can cause an economy to become mired in slow growth for longer than the historical economic models would predict – consequently making the stagnation secular (longer-lasting) rather than merely cyclical.
It is interesting that Chair Yellen chose to bring up secular stagnation in her latest public policy speech. The policy implications are clear: If the Fed is indeed worried about secular stagnation, this suggests that short-term interest rates will be kept lower for longer than is currently anticipated.
My guess is that Ms. Yellen does not want to raise interest rates this year, and that she raised the possibility of secular stagnation to give the Fed “cover” for not raising rates. She basically admitted as much in her latest speech in which she said that the mere possibility that the US could slip into economic quicksand “has important monetary policy implications for the near-term.”
I am very surprised that her concern about secular stagnation has not received more attention in the media. In any event, I will leave our discussion of secular stagnation there for today. I’m sure I will have more to say about it in the weeks and months to come.
Bottom Line: The Fed Doesn’t Know When to Raise Rates
As noted above, there is no consensus within the FOMC as to when to enact the first Fed Funds rate hike, or liftoff, as the Fed refers to it. The minutes from the March 17-18 policy meeting reveal a widespread disagreement among the Committee members regarding when the Fed should make its first move toward normalization. Take this excerpt: Several participants judged that the economic data and outlook were likely to warrant beginning normalization [rate hike] at the June meeting. However, others anticipated that the effects of energy price declines and the dollar’s appreciation would continue to weigh on inflation in the near term, suggesting that conditions likely would not be appropriate to begin raising rates until later in the year, and a couple of participants suggested that the economic outlook likely would not call for liftoff until 2016.
The point is there is no consensus among the Committee members. In addition, there is disagreement among the members as to how much the Committee should communicate with the public about the timing of the first rate hike, whenever such a decision is reached.
With regard to communications about the timing of the first increase in the target range for the federal funds rate, two participants thought that the Committee should seek to signal its policy intentions at the [FOMC] meeting before liftoff appeared likely, but two others judged that doing so would be inconsistent with a meeting-by-meeting approach.
Finally, many participants commented that it would be desirable to provide additional information to the public about the Committee’s strategy for policy after the beginning of normalization.
The minutes also suggest that, going forward, the Committee will simply consider the subject of a rate hike on a “meeting-by-meeting” basis, and that any decision would be “data-dependent” (i.e.: subject to further improvement in the economy and labor markets). Given the disagreement over timing and how much advance notice should be provided, I continue to believe that we will not see a rate hike until September at the earliest.
As Fed Contemplates Liftoff, Investors Head for the Exits
For reasons that are not entirely clear, investors are sensing trouble ahead for the US equity markets. A combination of a possible Fed rate hike, the stronger US dollar, weakness in the economy of late and falling earnings for US corporations finally has investors spooked.
Outflows from equity-based mutual funds and ETFs have reached their highest level since the darkest days of 2009, just as the recession was ending and the Fed was kicking its zero interest rate policy and quantitative easing into high gear.
Funds that invest in stocks have seen $44 billion in outflows, or redemptions, year-to-date, according to Bank of America Merrill Lynch. Equity funds have seen outflows in six of the last seven weeks, including $6.1 billion in the last full week of March.
The biggest outflows, by far, have come from the most popular ETF, the $193 billion SPDR S&P 500, the fund that tracks the index of the same name. The “Spider” as it is called has seen redemptions of $26.1 billion as of the end of March this year, more than eight times the second-biggest outflow victim, the iShares MSCI Emerging Markets Fund, which has given up $3.2 billion, according to ETF.com.
Apparently, many investors share my recent concerns about the elevated risks in the market and are moving to reduce exposure to stocks. But rather than sitting on the sidelines, I advise that you consider the actively managed programs such as those I recommend that can move to the safety of cash, or hedge long positions as warranted.
Gary D. Halbert is the president and chairman of Halbert Wealth Management, Inc. His Forecasts & Trends Weekly E-Letter may be obtained free of charge by subscribing at www.halbertwealth.com