The buzz on Wall Street these past few weeks has been the phrase “lower for longer.”
When investors say that, they are talking about the Federal Reserve and its likely policy on short-term interest rates. The Fed is expected to keep the cost of borrowing money lower for longer than was previously expected.
Depending on who you ask, this outlook may have consequences for your investments.
As recently as late last year, there seemed to be a consensus that short-term interest rates would be increased by up to four times this year, with each hike increasing the short-term borrowing rate by 0.25 of a percentage point, for a total addition of 1 percentage point over the year.
That view now seems like ancient history.
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So far, there has been only one rate hike since the end of the Great Recession. It was December, when the Fed increased rates from near zero to a range of 0.25 to 0.5 percent.
This year there have been no rate increases, and Fed Chair Janet Yellen has already signaled a reluctance to raise rates this week. Regardless of whether anything moves immediately, it has become clear that the economy is nowhere near as strong as was recently believed.
As a result, even if the cost of borrowing is increased, some observers believe that the Fed will remain cautious, at least for a while.
Low rates are still driving stocks. “That’s one reason stocks are back close to all-time highs,” says Peter Tchir, managing director of macro strategy at Brean Capital in New York. Stock investors like the idea of low borrowing costs and have piled into the market.
The Standard & Poor’s 500 index surged close to an all-time high this month, and is poised to threaten that mark this summer.
“It’s also decent for junk bonds,” says Tchir, referring to high-yield corporate bonds issued by less creditworthy companies.
The spread, or the amount which junk-rated borrowers pay more than the government pays to borrow, has shrunk from 7 percent to less than 6 percent since May, according to the St. Louis Federal Reserve. That lower spread has made junk bonds worth more.
A potential for turmoil. But it is not as if Tchir is sanguine on the investing outlook. “There is a worry that the Fed may want to put at least two interest rate hikes on the table this year,” he says. “But the market doesn’t see the necessity of doing so.”
That conflict in outlook, if it materializes, could cause market turmoil.
If the Fed does decide that it simply must raise rates twice before January, then that could send stocks spiraling down, Tchir says.
Investing is stocks is about expectations, in this case about what the central bank will do. What is now expected by the average investor has changed radically over the last six months.
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What happens in the long term? There could be problems for the commodities market, if historical patterns of rate hikes are anything to go by.
“When interest rates start to spike, they hit commodities,” says Brad McMillan, chief investment officer for Commonwealth Financial Network.
“We see that typical increases over a period of a year, once they get going, have been at a level of 2 percent or more,” McMillan says in a recent research note. “But history shows that once it starts, it’s likely to move more rapidly than the market is now pricing in.”
Once rate hikes start coming, expect them thick and fast — and that, in turn could torpedo a recovering commodity market.
Another view. Not everyone thinks that what the Fed does will change much of anything at all in the economy, or for that matter in the market.
When the Fed changes the so-called federal funds rates it is changing the rate that commercial banks charge each other to borrow, says John Tamny, a scholar at the Reason Foundation, and author of the recently published book, “Who Needs the Fed?”
He says the banking sector is regulated and inefficient, so changes in borrowing costs don’t really do much to boost the economy. He says that Silicon Valley investors likely won’t change their view on a potential enterprise just because the government changes the cost of borrowing by 0.25 percent.
On the stock market front, he’s not convinced it will make a difference either.
If continued low interest rates cause a rush of buying, then by definition there must be a rush of selling, he says. That’s because for the purchase of every single stock there must be the sale of an equal number of stocks.
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“For me to express that bullishness then someone else has to express an equal amount of pessimism,” Tamny says.
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What ‘Lower for Longer’ Means for Investments originally appeared on usnews.com
