No Recession if Rates Rise

A Bank Vault

A Bank Vault

Research by Oxford Economics shows that the US economy would not fall back into recession if the Fed decides to raise interest rates. Great news! However, there would be many negative consequences for growth and financial markets should they decide to raise interest rates more quickly than previously predicted.

The markets are uncertain, and the Fed has discussed raising rates sooner than their initial forecast of holding off until June 2015 before raising the federal funds rate, so Oxford Economics, and Kathy Bostjancic wanted to research what would happen if those markets dictated an steeper increase.

The Federal Open Market Committee (FOMC) has the difficult task of having to find the best time to raise rates and then communicate that to the investors. Financial markets in the past have proven to be susceptible to sudden tightening of economic policy. This happened in 1994.

The conclusion is that if the Fed does rates, as it said it might do sooner than previously anticipated, there would be consequences to stock and bond markets but it would not trigger a bear market.

The reason the Fed is considering tightening it’s policy is wage pressures which could lead to inflation. The Fed is worried about inflation, but they have stated their number one goal is full employment. There are signs that these wage pressures are already building. The unemployment rate gap measures show little slack in the short-term unemployed.

The possible impact higher rates could have on the economy include less growth, less business investment, slower housing market activity, and a stagnant unemployment rate. This stagnant unemployment rate is contrary to the Fed’s goal of full employment.

There would, of course, be a positive effect as well, in the form of foreign investors interested in safe investments in a stronger dollar. This, according to Oxford Economics, would not offset the negative impact of increasing rates.

One thing is for sure, it’s important the Fed’s communicates and manages market expectations. Whether investors will listen remains to be seen.



Who is Janet Yellen?

Janet Yellen is now a household name now that she has been appointed a the Chair of the Board of Governors of the Federal Reserve System. She had served as the vice chair making her the likely successor to Ben Bernanke. An impressive woman in a small frame is the first woman to hold this important position. In 2014 she was ranked as second most powerful woman in the world by Forbes Magazine.

Yellen was born in New York city to Jewish parents and ended up going to Brown University ultimately getting a PhD from Yale University in economics. She is married to George Akerlof who is quite the economist in his own right.  In 2001, George won the Nobel Memorial Prize in Economics, but one of his more popular articles is, “The Market for Lemons” in which Akerlof discusses markets with severe asymmetric information like used cars. His Nobel Prize is shared with Joseph Stiglitz who also oversaw Yellen’s PhD thesis.

After graduating Yellen went on to teach at Harvard and The London School of Economics. In the 1980’s Yellen taught and researched at UC Berkeley where her husband continues to teach.

Yellen started her career in the political realm in 1997 when she served as chair of Bill Clinton’s Council of Economic Advisors. This is the Bill Clinton that whose economic policy had one of the most popular and was liked by both parties. She eventually moved on to The Federal Reserve Bank of San Francisco in 2004 where she, in many ways, predicted the crash as a result of the housing bubble. In fact, her predictions throughout her career have been impressive.

Wall Street Journals' Ranking of Fed Forecasters

Wall Street Journals’ Ranking of Fed Forecasters

In Wall Street Journals’ ranking of fed forecasters, Janet Yellen was number one.

In 2010, Yellen was sworn in as vice chair of the Fed by Ben Bernanke, who was the chair of the Fed at that time. Four years later Yellen was confirmed as the Fed chair.


New Regulations for Foreign Banks and Governments

Kathy Bostjancic was recently quoted in this article
Economic Pieces

The Simplest Economics

She comments that  the reduction of repo treasury supply is a result of the regulations and constraints imposed on dealers’ balance sheets. She states that the Fed and other regulators want to prevent repeating the ’08 financial crisis where investment banks relied heavily on repo for short-term funding, and that this played a significant role in the financial crisis. This frames the entire article.
In essence the US Treasury wants to increase control of their destiny by asking repo and treasury traders to voluntarily report holdings. There is fear, however, that this added regulation will result in significantly less investment. 
Foreign states will be especially reluctant to report. China and Japan, for example, hold the most treasury bonds and it is detrimental to upset them in any way. 
The US Treasury, on the other hand, believes that since reporting is voluntary there will not be a significant negative effect from the new regulations. 

Kathy Bostjancic Interview

Ayan: Thank you so much for coming Kathy the agenda for today is an agenda of global markets one thing to discuss is the impact on the equity markets on other markets because of the Portuguese yesterday, did that calm down? How do you look at it?
Bostjancic: Sure there’s a lot to digest I think the first thing I would say is that they’re still  the FOMC which is still being led by the DOEs. So overall the message was, we’re in no hurry to raise interest rates they will stay low for a very long period. But other commentary that was very prominent in the minutes was just talk about investor complacency and excessive risk-taking. Another way to look at it is that investors undervalued risk or uncertainty going forward. What’s ironic about that is the Federal Reserve itself and the FOMC particularly is engineering that, because they continue to have this what I would say extreme forward guidance for the markets, they say that interest rates could stay low for a considerable period of time even once a quantitative easing ends. And which we now know will probably end in October but even beyond that, they said when the unemployment rate gets below the natural rate of unemployment the potential which most people think is around five and a half they could still continue to keep interest rates low because they think they’re so much excess capacity in the labor market.
Ayan: What the market doesn’t seem to believe that. Why is there such a discrepancy and what is your expectation?
Bostjancic: Rate lift-off expectations so we now think that they will exit this near zero percent strategy in the second quarter of 2015 so it’s not this year, it’s not the first quarter but the second quarter, but we were in the third quarter so we really  could afford a bit because the labor market indicators in particular were better. The latest employment numbers of non-farm payrolls fell more and more quickly but also long-term unemployed which is what Janet Yellen worried about came down a the other thing is a a guess on the margin you’re seeing so indications that wages are going to pick up and it may be more quickly than the Federal Reserve believes.
Ayan: I’m glad you mention that because unemployment coming to the level that they put the numerical targets inflation picked up right?  but the wage inflation is not there because we have the price inflation but do not have the wage inflation and we haven’t seen it for a long time, what is your expectation?
Bostjancic: What we see is some indications it was mentioned even in the minutes, small businesses plans on actually increasing wages and that’s a great leading indicator for broad which measures in general. So that may mean that it won’t be too long, maybe another two quarters or so, before we actually start to see which is bigger that’ll be good news for the consumer. I would also argue that is good news for corporate america assuming that inflation rises just as fast maybe a touch faster because corporate America needs pricing power to generate revenue growth and if you know anything about the equity market which really critical for the equity market is not just with the Federal Reserve. But they need to have steady growth to maintain this positive momentum.
Thank you.

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