Pundits were previously in favor of a Fed move by a small percentage in December. That is now a solid majority. Markets anticipate a Fed move. Hmm?
Torsten Slok (Chief International Economist, Managing Director of Deutsche Bank (DE:DBKGn) Securities, Inc.) has a wonderful chart series. Here are two, with his permission to share with our readers.
The first shows, since 2009, market-based pricing of a Fed lift-off and how wrong it has been. So let’s ask a simple question. Would you bet real money on this track record? Check it out for yourself:
The second chart shows the predictions of the so-called experts. Confession: several of them are resident at Cumberland Advisors.
Facts
- Nobody knows what the Fed will do in December, even though it seems they are leaning toward a quarter-point hike.
- If they do hike a quarter, that rise is already priced into market expectations. But what if they hike an eighth, or five basis points, or do something else?
- The external influences on the Fed are now intensifying. We wrote about that last week.
- The Eurozone is the key influence. European Central Bank policy is heading for expansion. To increase QE, the ECB must take the excess reserve deposits rate below the rate on the securities it buys. Right now the ECB pays (charges) minus 20 basis points (-0.20%) to national member banks that place deposits with their national central banks within the ECB. But the rate of the highest-credit-quality short-term securities is now lower than that (minus more than the deposit rate). So, the ECB must lower the deposit rate (take the rate more negative) in order to have a positive spread when it acquires securities issued by a high-grade sovereign like Germany.
- $2 trillion in European sovereign debt is now trading below zero. That number may grow to $3 trillion by the end of next year if the ECB pursues the policy it seems to have affirmed and may remain that high if the ECB stays the course.
Folks, let’s think about this. How high do US interest rates go when the second largest capital-market block in the world (the Eurozone) is in negative rates and those rates are going lower? And while the dollar is soaring and inflation is low.
Lastly, take a close look at the market-based, chain-weighted pricing of the PCE (personal consumption expenditure deflator). It is hovering around 1%. This is the measure that excludes assumed and estimated components of inflation and uses only those that are based on actual transaction prices. Conclusion: inflation in the US is low.
So, we expect the Fed to do a single hike and then stop. And then look around for one or two or three meetings to see if there is fallout. Then maybe do another hike and again stop and look around. Fed funds a year from now look to be at 1% or lower.
Meanwhile the dollar gets stronger as the spread widens between the USD and the currencies of the other major mature economies of the world.
We remain nearly fully invested in our US stock market ETF accounts. We like the currency-hedged approach in certain foreign markets. And we like the very-high-grade muni sector, where we are positioning a very attractive structure for our clients at 4.0% tax-free. Pretty good for an American taxpayer – taxable equivalent yield of 7% with three-day liquidity in an emergency. And negligible credit risk. Yummy!
Lastly, well-selected MLPs are dirt cheap. The entire sector has been murdered. Baby, bath water, and the tub itself were thrown out as funds had to liquidate all their holdings to fund the redemptions. We are on the buy side of MLPs after careful selection and research-driven decisions.
David R. Kotok, Chairman and Chief Investment Officer.