Policy Updates & Time Lags
The Federal Reserve (Fed) paused and held short-term interest rates flat in September. The decision made at the last Fed meeting was the first decision to pause since the Fed started its current rate cycle. The Fed may have kept short-term rates unchanged last month, but that comes after increasing rates a full 5% in less than 20 months. Rate increases may be the correct policy action, but the economy hasn’t felt rate increases at this speed in a long time. In no period, starting after Chairman Greenspan, has the Fed acted this aggressively with interest rate policies.
This new era of monetary tightness has kept short-term rates above long-term rates for an unusual period. Long-term interest rates have remained below short-term savings yields for nearly a year. But the tides may soon change because bond investors won’t tolerate losing money on long commitments forever. As a result, long-term rates rose significantly in September and stayed there. Even so, long-term rates have further ground to cover before they overtake short-term yields. Still, the recent move to higher levels could signal that restrictive interest rate policies are starting to enter the economy and exert influence over future investment decisions.
Financial market policies designed to slow down nominal growth are also happening in many places outside of the US. Monetary authorities in Europe and the UK, for example, are far down the path of creating tightness in the global system of financial settlements. Behind the change is a global coordinated effort to reduce continental inflation and preserve the international exchange values of these important monetary systems. As a result, the European Central Bank (ECB) raised its interest rates last month before the Fed decided to pause. The increase by the ECB shook bond markets last month. Bond markets further shuddered at the thought that the Fed doesn’t intend to stop its current rate cycle anytime soon. As a result of these international policy decisions, recent strength observed in the US dollar has begun to move sideways.
Other examples that monetary policy restrictions may be starting to enter the globalized economy include factors tied to manufacturing and future consumer demand. The US basket of leading economic indicators recently turned in the wrong direction. Specifically, new orders at plants are falling, and consumers say they’re growing less confident in their financial situations than they were one year ago. Mortgage rates are also much higher than a year ago, probably contributing to consumer sentiments when asked about their future financial security. Today’s interest rate environment has also hit the brakes hard on the housing sector, leading to less mobility, reduced affordability, and insufficient availability. Unfortunately, none of those attributes appear pro-growth. However, the prior examples may only be observations of the economic lag that usually occurs after new policies go into effect.
Given enough time, traditional market forces should prevail and correct any misallocations of capital. Therefore, it is rational to believe long-term investments will earn higher returns than short-term reserves again in the not-so-distant future. But to get there requires hard work, innovative thinking, and a societal willingness to accept risks. In the past, America and its capital markets have excelled at such things. There is no reason why it can’t happen again, as technology and better living standards have provided fertile soil for humankind to pursue cutting-edge innovations in fields related to AI, biotechnologies, and energy research. Those advanced solutions have the potential to produce long-lasting changes regarding how consumers participate in the economy. When investors zoom out to get a better picture, they may no longer care to know why interest rates have moved like stock prices as of late or worry about getting pinched by another cycle of inflation. Innovation is occurring throughout our economy, which can be a driving force for many investments. Considering these factors from a long-term investment planning standpoint is important, regardless of Fed policy or other forces outside our control.
