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Back when I was in high school a popular British band called The Fixx released the hauntingly catchy tune "Saved by Zero." I remember liking the song, though I had no idea what it was about. Who was this Zero guy anyway? What exactly did he (or she) save? No matter, when you're seventeen the search for deeper meaning is fleeting.
Since the 2008 financial crisis the US Federal Reserve Bank has been playing its own version of "Saved by Zero." I'm alluding to, of course, the unprecedented monetary policies of our central bank and its efforts to drive interest rates toward zero. When the entire financial system was on the cusp of nuclear meltdown, then-Fed Chairman Ben Bernanke made the bold decision to nail the Fed Funds Rate to the floor and launch something called "quantitative easing." It was unconventional, it was extreme – it worked. Super-easy and ultra-cheap credit was the right medicine at the right time, arguably saving our financial system from a complete collapse. Zero was our hero.
Few doubted back in 2008 that extreme action was needed, but today the picture is quite different. The economy is growing (albeit moderately), financial institutions have healed, jobs have largely recovered and the stock market is at new all-time highs. It almost feels "normal" again – not great, but not all that bad either. And so it begs the question: Do we still need Zero to save us?
At some point the Fed will surely start playing a different tune – a tune called "Escape from Zero." Investors everywhere are anxiously awaiting the release of this new song, yet none look forward to it. The lyrics, which are still being written by Janet Yellen and company, are destined to be steeped in deep meaning for financial participants. Many have already decided they won't like this new tune, with the International Monetary Fund (IMF) and the World Bank recently going so far as to publicly warn the Fed against raising rates too soon. The global economy is too fragile, they say. Higher interest rates will choke off the recovery.
For our part, we believe the Fed is likely to initiate "liftoff" sometime this year, perhaps during their September meeting. Any renewed signs of economic weakness between now and then, however, could easily delay such a move. What may be more important is what comes next. Does the Fed doggedly pursue rate "normalization" throughout 2016 or does it err on the side of being too easy for too long? No one knows for sure, nor do they know the impact "Escape from Zero" will have on financial markets.
Of course, it is obvious that bond investors will get creamed when the Fed does start raising rates – or is it? As Jared Nishida discusses in the following article, the risk to bonds may be overhyped and misunderstood. In fact, bonds may represent an important source of safety, especially in uncertain times like today. In the last article, Cam Johnson further explores this counter-intuitive nature of risk management and how our instincts often betray us at the worst possible times.
The Fixx, by the way, followed up "Saved by Zero" with "One Thing Leads to Another," an even bigger hit. Let's hope the Fed can do as well with its next tune.
This document represents the opinions of the author as of 6.17.2015 and is subject to change at any time due to market or economic conditions, or other factors.Print