Hike Rates, cut rates; behind the curve, ahead of the curve….What’s really going on in the markets?
We believe that what’s really going on is that the limits of effective monetary policy have been reached. We’ve hit the wall.
The point of cutting rates is to reduce the cost of borrowing. Lowering the cost of borrowing is supposed to stimulate demand for capital because investments which were unattractive at higher rates should now be attractive at lower rates. Once interest rates reach zero, that’s a strong indication that no one wants to borrow, meaning that the stimulative effect of monetary policy has run its course.
The problem, then, becomes one of (very weak) demand, which cannot be strengthened by making money even cheaper.
Since US consumers are doing their fair share in keeping consumer demand afloat, it would seem then, that the weak spots are business and government spending.
But the US government is running multi-trillion dollar deficits, so how can government demand be at fault? Because the tax cuts went to corporations and wealthy individuals who In turn, allocated their excesses to the capital markets. And this goes a long way to explaining the strong demand for stocks and historically low-yielding bonds, while the demand for most other, mostly “real” stuff is soft.
In Europe, the land of negative interest rates across the curve, a chronically anemic level of deficit spending translated into an anemic supply of government bonds, which allowed central bank buying to drive rates below zero very early on. This means that the ineffectiveness of monetary policy kicked in sooner and growth rates there are stuck in stagnation. This could also mean that governments there aren’t doing their share of deficit spending.
So we experience deeply unsettled markets, a Fed that delivers a 180 turnabout in a 2-week time frame, interest rates are lower than at Depression levels, and negative rates across the globe, even with reasonably high levels of employment and firm consumer demand.
We believe this strongly suggests that the generally accepted paradigm of capitalism, as re-defined in the post-Reagan era, is at a major inflection point.
Joseph A. Abraham, CFA
Senior Vice President, Direct Client Investments
