Bill Gross' December Investment Outlook

Link to Gross' December investment outlook. Please note that this link will cease to work after next month's outlook comes out. By then, hopefully this link could take you to the article.

In this report, Bill Gross compares the developed world's central banks' monetary policies of the past decade (i.e. quantitative easing and zero interest rates) to a losing gambler who doubles down in hopes of breaking even before going bankrupt.

Author is also on Twitter

The Debt Supercycle

Let's hear it from Kenneth Rogoff. Here's his article published in the Financial Times on Oct. 10, 2015.

This slowdown is a hangover not a coma.

Why should we listen to Rogoff? Because he is a Harvard professor and has studied 8 centuries of debt-laden financial crises in his 2011 book entitled This Time is Different.

Rogoff's profile on Wikipedia.

Author is also on Twitter.

Pioneer Quantitative Fund Managers

1. Renaissance Technologies
• James Simons, MIT-educated mathematician and Pentagon codebreaker
2. AHL
• flagship arm of Man Group
• AUM $12bn
3. Winton Capital
• David Harding, Cambridge-educated physicist
• helped set up AHL before selling it to Man Group
• one of the founding fathers of the CTA (commodity trading adviser)  strategy, a trend-following strategy employed across a variety of markets
4. Systematica Investments
• Leda Braga, engineering PhD
• spin-off of BlueCrest
• AUM $9bn
5. DE Shaw
• David Shaw, Stanford computer scientist
• AUM $37bn
• Fortune magazine calls him the "king quant"
6. AQR
• Clifford Asness
• AUM $130bn with $30bn in risk parity funds
• also manages CTA funds
7. Bridgewater
• Ray Dalio
• AUM $70bn in All Weather risk parity fund
• also has a classic macro fund named Pure Alpha
8. Two Sigma
• DE Shaw alumni David Siegel and John Overdeck
• AUM $25bn

AUM = assets under management

Excerpted from Financial Times, US print edition, Oct. 1, 2015, p. 9.

Author is also on Twitter.

US Equity Market's response to possible Fed rate hike tomorrow

Here's what John Hussman had to say about this matter in his weekly newsletter this week.

“First and foremost, the response of the equity markets to Federal Reserve easing (and much other news) is conditional on the risk-tolerance of investors at the time, which we infer from observable market action such as internals and credit spreads, among other factors. Quantitative easing ‘works’ by creating default-free liquidity in an environment where that liquidity is viewed by investors as an inferior asset. That is, if investors are risk-seeking, as inferred from the uniformity of market action across securities, sectors and asset classes of all risk profiles, then yes – Fed easing will tend to support further advances in stock prices regardless of the level of valuation. On the other hand, once investors have shifted toward risk-aversion, overvalued markets become vulnerable to abrupt free-falls and crashes, and monetary easing is not materially supportive for stocks because default-free liquidity is desirable. [Highlights in bold are mine.]"

In previous weeks and months, investors have been shifting to risk aversion, according to Hussman's inferences from observable market action. This means that downside risk exceeds upside potential ...

Hussman further says in this week's newsletter that,

"A quarter-point hike will not cause anything. The causes are already baked in the cake. A rate hike may be a trigger with respect to timing, but that’s all. [Highlight is mine.]"

Author is also on Twitter.

On tomorrow's Fed decision to hike rates

for the first time after 11 years

Tomorrow will be the first time since 2004 that the US Fed may raise the Fed Funds rate. (See this source for historical rate hikes including the one from 2004.)

Here are a couple of opinions as excerpted from John Hussman's weekly newsletter for this week.  

In brief, (a) it doesn't matter to the real economy and (b) not raising rates increases the risk of financial dislocation and global recession. Item (a) is Hussman's opinion and (b) is Albert Edward's.

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Here's Hussman's opinion.

"With regard to a possible quarter-point hike this week in the amount of interest that the Fed pays banks on idle excess reserves, our view – frankly – is that it doesn’t matter. [Highlight is mine.]" 

"With respect to the economy, we know that a quarter-point means nothing, given the weak correlation between policy rates and subsequent output, employment and inflation. From a purely economic standpoint, my impression is that the main effect of hiking interest rates would be to draw zero-interest currency into the banking system in the form of even more idle reserves. We’re already seeing indications of an economic slowdown, but the impact of a quarter-point hike on that dynamic is meaningless. The economic slowing we’re seeing here – which as yet isn’t strong enough to warn of recession – was already developing in February (see Market Action Suggests Abrupt Slowing in Global Economic Activity) and based on declining new orders, falling backlogs and rising inventories, is still underway. [Highlights are mine.]" 

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John Hussman also provides Albert Edward's opinion from SocGen the French bank. His view is as of last week.

“The clamour for the Fed not to enact the long-awaited ¼% rate hike next week is growing by the day. Misgivings come not just from reputable mainstream commentators, but now also the World Bank has repeated the IMF’s recent words of caution in advising delay. What a load of nonsense! My esteemed colleague Kit Juckes characterizes the current consensus thinking as ‘If the Fed hikes, pestilence, plague and never-ending deflation will follow.’ Well even those like me who see a deflationary bust awaiting think the Fed should hike next week – because the longer you leave it, the bigger the financial market excesses become, and the bigger the risk of financial dislocation and global recession ensuing. Have we learned nothing from the 2008 Great Recession? Just get on with it! [Highlights are mine.]" 

Author is also on Twitter.

US Fed Funds Rate Impact on GDP Growth

Historical evidence suggests that for every 1% decrease in the Fed Funds rate GDP growth rate increases by 0.1% which is not a whole lot. 

Unfortunately, the accuracy of this relationship is only 4%!

The above information was extracted from John Hussman's weekly newsletter for this week.  Please see the chart below which is the first chart in that newsletter.

Author is also on Twitter.

On the Correlation between Unemployment & Inflation;

also, known as the Philips Curve

This is what Econ 101 teaches us about the relationship between unemployment and inflation. It's called the Philips Curve.  Apparently, the US Federal Reserve bases policy decisions on it.

Here's what quantitative equity fund manager John Hussman has to say about this relationship.

"You’ll find a ... shotgun scatter of uncorrelated points if you plot unemployment versus general price inflation, for example. It’s unfortunate that the Federal Reserve is actually allowed and even encouraged to impose massive distortions on the U.S. economy based on relationships that are indistinguishable from someone sneezing on a sheet of graph paper. [Highlights are mine.]"

In a nutshell, the Philips Curve is a fallacy.

The above quote was excerpted from Hussman's weekly newsletter for this week.

Author is also on Twitter.

Greece Prediction by Wolfgang Munchau

On July 20, the same day that Greek banks reopened after a three-week bank holiday, the Financial Times published the following article by Wolgang Munchau. (I had previously provided a timeline of events in Greece; please scroll down past the halfway mark ...)

Highlights from the article are as follows.

• "Grexit remains the most likely ultimate outcome after all.

• There are three principal ways in which this can happen.

1. The first is that a deal [between Greece and its creditors] is simply not concluded.
2. A more likely Grexit scenario is that a programme is agreed and then fails.
3. The most probable scenario ... is Grexit through insurrection.

• Greece is not quite at the point of insurrection yet — despite eight years of recession. 

• If Syriza fails to deliver, ... the Greeks will have no democratic choices left."

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Wolfgang Munchau is the director of Eurointelligence.com, a specialist service for economic news and analysis of the euro area.  He is also on Twitter and writes for the Financial Times.

Author is also on Twitter.

Exciting July for Gold, Greece, & China

• Gold 5-year low
• Greece exited the Euro almost
• Chinese stock market crash
• Falling commodity prices
• US stock market prediction

Gold 5-year low

The gold price closed on July 24, 2015 at $1,098 per troy ounce after hitting a low of $1,072. This was a 5-year low! It caught my attention, so I decided to blog about it.

An article in the Financial Times dated July 25 covered this topic. Some key points were as follows:

• Goldman Sachs, one of the most influential banks in commodity trading, cautioned in the week ending July 26 that it expected gold to fall below $1,000.

• Julian Jessop of Capital Economics says that gold may return to levels of about $850 as the Fed moves toward raising interest rates (which is expected for September or December this year). An $850 price level was last seen in 2007.

• Predicting where the gold price may bottom is difficult because gold isn't like metals which have industrial uses such as copper and zinc.

• Gold bugs believe that China is not being truthful about how much gold it has bought. Whereas its official gold holdings stand at 1,658 tonnes, gold bugs believe that it actually holds an amount closer to those of Germany at 3,444 tonnes. (China recently reported an increase of about 600 tonnes which was much less than expected by pundits.)

• Texas-based former stockbroker Bill Holter is bullish on gold. He says, "I can calculate on the back of a napkin that China is buying more gold." He adds that import data support his view. [Someone ought to verify this, please!] "Mathematically, [the world's current build up of debt] is guaranteed [to pop], it is just a question on when." 

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Bill Holter publishes here.

By using Google search, Bill Holter led me to Jim Sinclair who led me to Canadian billionaire Eric Sprott, all gold bugs. Eric Sprott said recently, "The demand numbers I’ve seen are way beyond the supply." Source.



Greece exited the Euro almost

It was on the weekend of June 27/28 that Greece surprised the world by announcing that it would hold a referendum and let its citizens decide on whether it should accept its creditors terms.  This was instead of Greece reaching an agreement with its creditors before a June-end deadline.

On Sunday, June 28, equity futures around the globe were trading down more than 3%. On Monday, June 29, the S&P500 closed down 2.1% from the previous Friday's close. It was also the first day of a week-long bank holiday in Greece.

The Greek banks ended up remaining closed not for one week as originally announced but for a total of three weeks (through July 19). See timeline here. In the interim, capital controls were imposed (€60/day withdrawal limit; most foreign transfers banned.)

It is in this context that the price of gold hit a 5-year low.  Actually, it hit its low in the first week after the Greek banks reopened, with the actual low occurring on Friday, July 24.

On July 23, the Greek parliament approved the agreement reached between Greece and its creditors. The Financial Times reported that Greece swallowed harsher terms than what was on the table prior to the referendum! 

The sequence of events was bewildering. First, the Greek leaders rejected the creditors' terms and opted for a referendum to decide whether or not they should accept the creditors' terms. Greek citizens voted in favor of rejecting those terms. Then Greece ended up accepting harsher terms than had been on the table prior to the referendum. 

To those who say that Greece is a small economy and it doesn't matter whether it stays or leaves the Euro currency, Bill Holter responded that there have been insurance contracts taken out in the form of credit default swaps (CDS) whose notional value is 10 times that of the entire Greek debt to foreign creditors. If Greece were to leave the Euro currency, it would probably also default on this debt. If it were to default, then these credit default swaps would have to be paid upon. The critical point is that it's not clear whether the issuer(s) of these CDSs would have enough capital to be able to pay. That's when there could be another massive financial crisis. 

Technically speaking, Greece didn't default on its debt on or about June 30 and none of the CDSs were triggered. But practically speaking, Bill Holter says that it did default because although it did make the required interest payments, it made them later than their due date.

So, the context was one of fear and uncertainty in my opinion. Yet gold responded counter-intuitively and went down ... Why? Time will tell.

-------------------

Background: Link to "How does a CDS work?"

Size of Greece's national debt is $300bn. Source. Size of Germany's national debt is over $2tn and is the 3rd highest in the European Union behind UK and Italy. The European nations with the highest absolute national debt amounts are UK, Italy, Germany, and France, each with more than $2tn of debt. Figures are as of Q1 2015. Source.



China stock market bubble burst

The Chinese A-shares stock market as represented by the Shanghai Composite Index hit a seven-year high on June 12.  This represented a rise of more than 2.5 times since the low point hit in January 2014 (18 months prior). From June 12, the index went on to fall 35% by July 9; see chart.

Chinese authorities then stepped in to pump up the stock market through draconian measures including banning short-selling, injecting capital by lending to brokers to support shares, and halting trading outright. Shares rose 11% by July 23 only to reverse course and fall again. As of July 31st's close, the Shanghai Composite stood 1% below the low point hit on July 9.

The selloff through July 9 had wiped out $3 trillion in value. Chinese authorities' failed bailout originally required $19.4 billion of capital. Source. This figure had risen to $350 billion by July 31, according to the Financial Times. Correction, Aug. 8, 2015: The $350 billion is incorrect! The Financial Times reported on Aug. 7 that Chinese authorities had already spent $144 billion out of a $322 billion war chest.

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The other major stock market in China is represented by the Shenzhen Composite Index. Chinese shares traded in Shanghai and Shenzen are also known as A-shares. By law, they aren't available to foreigners for purchase. (However, foreigners can set up local operations to buy A-shares; one example is US hedge fund Citadel.)



Commodity prices are falling

In the same week that gold hit a 5-year low (July 19-25), the Financial Times reported on falling commodity prices. The general reasons seem to be lack of demand, too much supply, slowing global growth, and expectations for a rising US dollar.

The fall of crude oil was exasperated due to expectations of Iran supplying oil to the international markets in the aftermath of its historic nuclear accord reached on July 14.

Timeline summary

Sat, June 27: Greece announces plans for a referendum to be held on July 5
Mon, June 29: Greek bank holiday begins
Sun, July 5: Greek referendum is held; Greek citizens reject the creditors' measures
Wed, July 8: Chinese A-shares stock index ends 35% below its peak of June 8
Tues, July 14: Iran reaches historic nuclear accord with G5+1 countries
Sun, July 19: Greek bank holiday ends
Thurs, July 23; Greece agrees to creditors' bailout terms
Fri, July 24; Gold hits a 5-year low

Footnote: I am not implying any causality between events in Greece, China, and commodity prices. I am merely pointing out coincidences.



US stock market prediction

I was looking at some stock charts and couldn't help but notice the coincidence involving the date June 29 which was pointed out in the above timeline. The chart below shows the percentage of stocks in the S&P500 trading above their 200-day moving average. It is a weekly chart and its most recent observation is for the last week in July.

The observation is that for the week starting Monday, June 29, this percentage fell below 60% and hasn't recovered since.

The blue arrow points to the bar for the week of Monday, June 29. Note that in October 2014, when this metric fell through the 60% level, it recovered after two weeks. This hasn't happened since June 29!

Because the x-axis spans two and a half years, we are currently experiencing something that has happened for the first time in two and a half years! What I'm trying to say is that it can't be taken lightly.

The following chart shows the S&P500 itself. This is also a weekly chart. Like the chart above, its most recent observation is for the last week in July.

In contrast to the chart above, this chart doesn't show any deterioration except for a flattening of the uptrend since May.

I look at this chart and I don't worry, but I look at the previous chart and I start worrying ... Due to the fact that the chart above has low points that are spaced 9 months apart (Feb. 2014, Oct, 2014, July 2015), I would speculate that if this pattern were to repeat, we'd have another low point in 9 months which would be ... March 2016.

Author is also on Twitter.

US Household Income Growth

by Income Bracket

How is the distribution of US household income growth different from other developed countries?

See the chart below for the answer.

What does this mean? 

Here's how I believe the above chart was produced. They measured household income in 1976 for every household in the US and summed up the figures. They then measured the same quantity in 2007 and adjusted it for inflation. Next, they calculated the difference between these two quantities and called it "income growth" across all households. Finally, they asked, how much of this income growth belongs to households in the bottom 90% of income, to households in the next 9%, and finally to those in the top 1%? The answer is what got plotted in the chart. 

The chart shows that in the US, about 20% of income growth in 1976-2007 belongs to households in the bottom 90% of income. (To understand what this means, the number 20% should be replaced with "small" while the number 90% should be replaced with "large".) At the other extreme, in Denmark, about 90% of income growth belongs to households in the bottom 90% bracket.

The flip side would be to compare income growth belonging to the top 1% bracket and the next 9% bracket ... The chart speaks for itself. The top 1% of households by income captured more than 40% of income growth while the next 9% captured almost 40% of income growth.

To put it in words, income growth in the US has predominantly gone to the top 10% of households. It has been narrowly distributed; actually, more narrowly distributed than in any of the other countries in the above chart. The country where income growth has benefited the largest percentage of households is Denmark.

In a nutshell, the chart presents countries in sorted order where the ordering starts with the country where income growth has benefited the largest percentage of households (Denmark) and ends with the country where income growth has benefited the smallest percentage of households (US).

What is the next chart about?

The chart below shows real median household income in the US by year. We can see that real median household income in 2013 was about $52,000 versus about $47,000 in 1985. This is an increase of 10.6% over 28 years and represents a small increase. 

The reason it represents a small increase is because when this 10.6% is annualized, it corresponds to a 0.36% compounded annual growth rate. This is a real growth rate, i.e. it has been adjusted for inflation. What it says is that the median household income has essentially been flat over the 28 years ending in 2013.

"Median" household income is that level of income such that half of households have a lower income than the median while the other half have a higher income. It represents a convenient (and meaningful) way to talk about a single, representative household in any society where household income happens to be distributed across a wide spectrum.

The above charts were excerpted from an article that appeared on ft.com on July 24, 2015 and was entitled "US income inequality rises up political agenda".

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Sanity check: 

I wonder why the first chart leaves out Germany and Italy which are major European countries. Also missing is Japan even though it represents one of the top economies of the world. 

Second, it would have been interesting if that chart has also included some of the countries from emerging markets such as China, India, Russia, and Brazil. I will venture to guess that there, income growth is even more narrowly distributed than the US ... 

Third, notice that the bottom 5 countries on the first chart are all English speaking countries.

The second chart actually shows that US real median household income has been falling since 1999 (except for a brief rise in 2005-2007)! The more nuanced way to interpret the second chart would be to notice that median household income has grown in waves: The first wave was from 1985-1995 during which US real median household income grew. The second wave was from 1995-2005 during which it grew again and this time much more than the previous time. The third wave was from 2005 onward during which it has not grown but fallen!

Author is also on Twitter.

What Nelson Mandela said to the Prison Officer

The following was recounted by African National Congress (ANC) stalwart Mac Maharaj who spent 12 years in prison plotting with Nelson Mandela; as excerpted from an article published by the Financial Times on July 25, p. 17 of the Life & Arts section.

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Mac recalls Mandela raising prisoners' complaints with General Steyn, the visiting head of correctional services, "an extremely polite man ... in a black suit with a hat, spotless white shirt ... General Steyn turns around and says, 'Mr. Mandela, you are not in a five-star hotel, you are in prison.' And I'm listening and saying, 'Oh boy, that man is in trouble.' Mandela says, 'General, you and I are at war. In a war nobody can predict who is going to win, but one thing we know, that at the end of the day we will have to meet, even if it is for you to accept my surrender. How that happens will be determined by how we treat each other.' Steyn changed overnight."

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Mac Maharaj is now 80 and one of the last survivors of the "golden" generation of Robben Islanders (the prison). Before his 12 years on Robben Island he suffered appalling torture at the hands of the police, including being suspended by one ankle out of a seventh-floor window.

He holds a unique record as confidant of three of the last four ANC party leaders (including Nelson Mandela). He first embraced liberation politics in the 1950s.

Author is also on Twitter

That Little Piece of Glass

If someone time traveled from 1990 (let alone from 1900) to 2015 and was asked to describe the difference between then and now, they might report back:

"Well, people don't use light bulbs any more; they use these things called LED lights, which I guess saves energy, but the light they cast is cold. What else? Teenagers seem to no longer have acne or cavities, cars are much quieter, but the weirdest thing is that everyone everywhere is looking at little pieces of glass they're holding in their hands, and people everywhere have tiny earphones in their ears. And if you do find someone without a piece of glass or earphones, their faces have this pained expression as if to say, 'Where is my little piece of glass?' What could possibly be in or on that piece of glass that could so completely dominate a species in one generation?"

Excerpted from an article appearing in the Financial Times on June 20, 2015, p. 20, Life & Arts section. The article was entitled 'The Prozac Principle' and written by Douglas Coupland, artist in residence at the Google Cultural Institute in Paris. Twitter @dougcoupland

Author is also on Twitter

US Fed Interest Rate Policy Update

Three months ago, I had written about the US Fed's interest rate policy. (See articles dated March 22, March 27, and April 23.)

Here's an update.

Janet Yellen spoke last week at her quarterly press conference. She advised listeners not to spend time wondering whether the first rate hike will come in "September or December or March".  Instead she advised her audience to concentrate on the pace of the rise in rates and said that the pace would be "gradual".

Her words hint at the possibility that the first rate hike may not occur this year. Prior expectations were for this to occur in September. Prior to that, expectations were for this to occur in June (this very month).

The Fed Funds futures market -- used for hedging purposes -- is implying with virtual certainty that there won't be a rate rise in September. In contrast, at the beginning of this year the futures market was signaling with virtual certainty that there would be a rate rise by then.

The futures market is now signaling a 50-50 chance of a rate rise by the end of the year.

Expectations about the timing of first rate rise continue to get postponed.


Excerpted from a Financial Times article printed on 20 June/21 June, p. 16.


Afterthought:  Bond expert Jeff Gundlach, who is CEO and chief investment officer of Doubleline, doesn't think that the Fed will raise interest rates this year. He shared his mind on June 3. See article here.

Author is also on Twitter

Concept of Time

"Italians' concept of time is radically different from most people I know in New York, and I'm realizing that I don't have to accomplish 29 things every day, and read the entire New Yorker while drinking my coffee from a paper cup and texting on a treadmill."

Jhumpa Lahiri, 47

Pulitzer-Prize-winning writer

Human Connection

"Here [in Rome at the local food markets], you know the person who bakes your birthday cakes, who makes your salami and cheese every day, and the people who sell everything you put in your body. And they know everything you put into your body because there's this deep, human connection that you create day after day."

Jhumpa Lahiri

Excerpted from Financial Times, 23 May/24 May 2015, page 16 of House & Home FT Weekend.

Author is also on Twitter

Excerpts from Bill Gross' 

Investment Outlook of May 4, 2015

A Sense of An Ending

Here's the link to Bill Gross' investment outlook report of May 4. (Note added on Dec. 5, 2015: They moved the article. Here's another link.)

The following comments stood out for me.

1) "[S]uccessful, neither perma-bearish nor perma-bullish managers have spoken to a “sense of an ending” as well. Stanley Druckenmiller, George Soros, Ray Dalio, Jeremy Grantham, among others warn investors that our 35 year investment supercycle may be exhausted."

2) "Since capital gains have dominated historical returns, investment managers tend to focus on areas where capital gains seem most probable. They fail to consider that mildly levered income as opposed to capital gains will likely be the favored risk / reward alternative."

Author is also on Twitter

20-year Interest Rate Forecasts

On September 24, 2014, I wrote about Joseph Stiglitz' review of Martin Wolf's latest book. 

In that article, the topic of interest rate forecasts came up. 

I had written that the Geneva Report was predicting that interest rates worldwide would have to stay low for a "very, very long" time to enable households, companies, and governments to service their debts."

An article published in the Financial Times on April 18, 2015 puts numbers to these predictions. The prediction is from Micheal Gavin at Barclays. Michael Gavin holds a PhD in economics from MIT, according to his LinkedIn profile.

Quoting from this article, "Mr Gavin estimates that all things being equal the natural real interest rate will rise by about 1 percentage point over the next five years, 2.25 percentage points over the next decade, and 3.5 percentage points over the next two decades."

Critics are likely to dismiss these forecasts as being unreliable. After all, who can say what the world is going to look like in 20 years? Nevertheless, I think that these forecasts ought to figure into one's thinking.

For reference, as of the time of this writing, the 10-year Treasury yield stands at 1.96%. The general expectation is for the Fed to raise interest rates sometime in the second half of 2015. This would be the first rate hike in nearly a decade. The Fed has held the Fed funds rate at close to zero since the Great Recession of 2008/2009.

Author is also on Twitter.

Stiglitz: Three Steps to Solve Income Inequality

On September 24, 2014, I wrote about Joseph Stiglitz' review of Martin Wolf's latest book. In that article, the topic of income inequality came up.

This month, Joseph Stiglitz' own book came out. In it, he proposes three steps to solving the income inequality problem in the US.

Yahoo had an article on the book which is entitled The Great Divide: Unequal Societies and What We Can Do About Them.

Stiglitz' three steps to solving the income inequality problem pertain to reforming:

1. tax laws
2. corporate governance laws
3. educational system

Author is also on Twitter.

US Fed's downward revisions:

What does it all mean?

After reading my previous post ("US Interest Rate Forecasts: Policy Maker vs. Market Forecasts", March 22, 2015), a friend who is not in the field of finance asked, "What does all this mean to the average reader?"  

Here's what I believe it means, and it's a matter of interpretation.

1) If interest rates are of concern to you, perhaps because you have borrowed money at a variable rate and would be adversely affected by an interest rate increase, you shouldn't get too worked up about the prospects of rising interest rates. They are likely to increase less than you were expecting, and later than you were expecting.

2) Since the Fed's mandate is to contribute to price stability, and since it raises interest rates to combat inflation, we now have reduced inflationary expectations associated with the Fed's downward revisions.

3) To the extent that low interest rates lead to higher asset prices (e.g. stock market prices, bond prices, real estate prices), this trend is likely to continue, all else being equal.

4) The US economy, despite being the best recovering economy in the world today, is still not strong enough to support higher interest rates. The rule at work here is that the more economic growth there is, the higher the prevailing interest rate. (In reality, it's the long-term interest rate that mimics the rate of prevailing economic growth. It is set by market forces. However, the long-term interest rate is correlated with the short-term interest rate over which the Fed has direct control.)

5) The Fed cannot always have things its way because there are other forces at play which are beyond its control. These would be market forces: the US dollar has appreciated because of market forces, because of individual decisions. The appreciated dollar will probably perform the job of Fed tightening and put a dampener on economic activity despite interest rates remaining low.

Side note: These individual decisions were primarily caused by the ECB's announcement last January to start QE (quantitative easing) in Europe from March 2015 through September 2016 and at the monthly rate of 60Bn Euros.  This has the effect of raising government bond prices in Europe and reducing their yields. Today, bond holders stand to earn more interest (or yield) on US government bonds than on their European counterparts. Hence the appreciation of the US dollar.

6) The Fed's policy guidance ought to be interpreted not in a vacuum but in the context of what the futures markets are saying. In this case, not only has the Fed revised its own projections downward, but the futures market is predicting interest rates that are even lower than the Fed's lower projections. Market prices represent the thinking of a large number of economic players who have voted by putting their money where their mouth is. They cannot be taken lightly.

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Getting more speculative,

I have read that that one reason that the Fed wants to raise rates sooner than later is because they are afraid of a bubble forming in the US equity markets. (But the Fed's mandate is not to prevent asset bubbles! It's to maintain price stability and full employment.)

I have also read that the Fed wants to raise rates sooner than later so that the next time that there's a recession, there would be room for lowering them. So the thinking is that if rates are low by the time that the next recession arrives, the Fed would have to use other means besides lowering interest rates in order to jump start the economy. But that would be nothing other than QE (quantitative easing)! Again? In what amount? What would that do to global confidence in the US dollar as the world's reserve currency? (Readers may want to do a Google search on "reserve currency" and read further ... E.g. Wikipedia article on reserve currency.)

Author is also on Twitter

US Interest Rate Forecasts:

Policy Maker vs. Market Forecasts

Last Wednesday, many listened to the Fed's statement as to when it expected to raise interest rates. The Fed funds rate has been at its current level since 2008; source.

Previously, concerns about a strong dollar had led many to speculate that the Fed would postpone a rate increase planned for an April-June time frame. The US dollar has appreciated almost 25% since May of last year versus the Euro. (1 Euro is worth $1.0817 today versus $1.3862 last May. Data source for historical exchange rates.) A strong dollar acts as monetary tightening for US exporters. It reduces earnings from goods and services sold abroad when translated back into dollars. (See afterthought at the end of this post.) 

Fed chairwoman Janet Yellen mentioned weaker forecasts of inflation and a downgrade to people's assessments of the long-run normal unemployment rate. Both of these imply postponement of rate increases.

There were dramatic reductions in median forecasts for official interest rates. 

FOMC members' median interest rate projections for 2015, 2016, and 2017 were reduced by 50-75 basis points from last December's projections (i.e. 3 months ago). 

However, futures markets are forecasting even lower rates than the Fed.

The FOMC's latest projections for the Fed's overnight borrowing rate are:

0.625% by 2015 year end, down from the previous forecast (last December) of 1.125%,

1.875% by 2016 year end,

3.125% by 2017 year end.

However, the futures markets' forecasts are:

0.5% by 2015 year end,

1.25% by 2016 year end,

1.85% by 2017 year end.

The Fed fund's rate is currently 0.12%; source.

(As excerpted from the Financial Times, March 20, 2015, page 24.)

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The above data is in terms of levels. We can also express them in terms of change in level. Then, the Fed's latest projected path of rate increases becomes: 

+0.5% change by 2015 year end,

+1.25% change by 2016 year end, 

+1.25% change by 2017 year end.

Meanwhile, the futures market thinks that the path of rate increases will be more like:

+0.38% change by 2015 year end,

+0.75% change  by 2016 year end,

+0.6% change by 2017 year end.

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Several observations are noteworthy. First, the market thinks that the Fed won't increase rates by as much as the Fed itself is projecting. This is obvious: In the last two data sets above, every line in the second data set is less than in the first data set. 

What is less obvious is that the market thinks that the third leg of tightening (+0.6%) will be weaker than the second leg (+0.75%). On the other hand, the FOMC is projecting identical tightenings (+1.25% and +1.25%). This suggests that the market sees economic weakness 2-3 years out whereas the FOMC doesn't ... Economic weakness would call for lower interest rates.

Furthermore, the market thinks that the "oomph" of the second leg (+0.75%) will be twice that of the first leg (+0.38%). In contrast, the FOMC's oomph for the second leg (+1.25%) is projected to be 2.5 times that of the first leg (+0.5%). This suggests that the market doesn't think the economy needs or can take that much tightening 1-2 years out.

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It will be interesting to keep track to see who ends up being right. 

It is important to remember that ultimately, it is the FOMC itself which sets the Fed funds rate, whereas the futures market can at best forecast it. The FOMC meets eight times a year: meeting calendars of the FOMC.

Previous expectations of a rate hike as early as June have now been replaced with September.

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Background

1. Question: Why is the Fed funds rate important? Answer.
2. Wikipedia article explaining the Fed funds rate.
3. FOMC = Federal Open Market Committee. About the FOMC.
4. Fed = US Federal Reserve System. Wikipedia article on the Fed.

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Why a strong dollar is bad for US corporate earnings

During a portion of last year (2014), when the US dollar appreciated by 5%, overseas earnings of US corporations fell by 7%. So, the multiplier effect exceeds one.

Furthermore, a good portion of S&P 500 company earnings come from overseas. Approximately 40% of S&P companies have overseas revenues, and 261 companies in the index have more than 15% of their revenues outside the US, according to data from S&P Dow Jones Indices. (Source: http://www.ft.com/, Jan. 19, 2015, "S&P 500 earnings face dollar headwind".)

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