Direction Matters More Than Position with Monetary Policy

Direction Matters More Than Position with Monetary Policy

As I was reading today, I ran across a quotation from Stanley Fischer, Vice-Chairman of the Federal Reserve. It was from an interview on CNBC in April 2015. I went to get the original source, and here it is:

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Still, Fischer emphasized that a tightening would be slight.

“We have to ask what will go wrong,” he said. “I say that if we get this in proportion, we’re going to be changing monetary policy from the most extremely expansionary we’ve been able to do in all of history, to an extremely expansionary monetary policy.”

Fischer added that the expected increase of a quarter of a percent would be the lowest rates had ever been if not for the recent move to zero.

This is the same mistake that Ben Bernanke made when he talked about the “taper” back in 2013, and the same error that Janet Yellen is making now. At any given point in time, there is a schedule of interest rates going out into the future that reflects the future path of rates that the Fed controls. This isn’t perfect because almost none of us can borrow at those rates, but if credit spreads don’t vary much, movements in the schedule of rates, driven by expectations of monetary policy, affect business actions.

This implies two things:

  1. Direction matters more than position in monetary policy. If expectations have moved from “zero for a long time” to “over 1% by the end of next year,” that is a large shift in expectations, and should slow business down as a result.
  2. As a result, you can look at the Treasury curve as a proxy for the effectiveness of monetary policy.

On that second point, I have collected the Treasury yield curves since the middle of 2015 on the days after monetary policy announcements. Here they are, so far:


Maturity 1MO 3MO 6MO 1 2 3 5 7 10 20 30
6/18/2015 0.00 0.01 0.08 0.26 0.66 1.03 1.65 2.08 2.35 2.86 3.14
7/30/2015 0.05 0.07 0.15 0.36 0.72 1.07 1.62 2.02 2.28 2.66 2.96
9/18/2015 0.00 0.00 0.10 0.35 0.69 0.97 1.45 1.83 2.13 2.58 2.93
10/29/2015 0.02 0.07 0.21 0.33 0.75 1.05 1.53 1.90 2.19 2.60 2.96
12/17/2015 0.18 0.23 0.48 0.69 1.00 1.33 1.73 2.05 2.24 2.57 2.94

You can see the impact of the FOMC tightening out to five years, maybe seven. After that, there is no effect, so far, except to say that the yield curve is already flattening, and that the Fed my end up stopping much sooner than many expect — including the FOMC and their “dot plot” which expects a 2%+ Fed funds rate in 2017, and 3%+ in 2018. Unless the long end of the yield curve reprices up in yield, there is no way those higher Fed funds rates will happen.

Which brings me back to Stanley Fischer. He’s a smart guy, perhaps the smartest on the Fed Board. Maybe he meant there was no way rates could rise much for a long time. If that’s the case, he may be way ahead of the curve. Only time will tell.


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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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