Doesn’t the Starting Point Matter?

By: Russ Kamp, Managing Director, Ryan ALM, Inc.

The US Federal Reserve didn’t disappoint anyone today, other than those who for some strange reason have been expecting the Fed to have eased by now and in some cases all the way back to last Summer. The Fed has now raised rates for 10 straight meetings bringing the Fed Fund’s Rate to 5% – 5.25%, which is up 500bps since they began elevating rates last March in an attempt to tamp down inflation.

Like you, I get tons of emails every day from one research firm after another proclaiming that this time has to be the last time of Fed hiking in this rate cycle. One firm stated just today that “in the past, cumulative hikes of more than 300bp or so have been enough to push the economy into recession.” But we’ve also never had a starting point of ZIRP (zero interest rate policy) and incredible stimulus in reaction to Covid-19 lockdowns. Doesn’t the starting point matter?

As a reminder, US interest rates bottomed in July 2020, with US Treasury Bills and Notes with maturities < 5 years posting yields below 0.3%, while the 10-year yield hit 0.55% and the 30-year had a yield of 1.2%. These were historic low rates. They were not sustainable and ultimately contributed to the inflation that we are still wading through today. But, even with the Fed’s increases, US Treasury yields are not much higher than they were 12 months ago for those with maturities of 5 years or more. In fact, the difference in yield for the 5-year Note 12 months ago versus today is ONLY 37 bps. Do you really believe that economic activity is going to be crushed with a yield differential of 37 bps? The spread for 7 years, 10 years, and 30 years today versus 12 months ago are not meaningfully different, too (32 bps, 41, bps, and 69 bps, respectively). Once again, do you really believe that these increases are crushing?

As I reported last week, the average 10-year Treasury yield for the last 70+ years has been 5.1%, a full 1.7% higher than the current environment. In order to combat inflation in the late ’70s and early ’80s, the Fed elevated the effective FFR to 22.29% or more than 4 times the current level. That was crushing!

You Gotta Love Charlie

Charlie, as in Charlie Munger, Warren Buffet’s right-hand man (last 45 years), and a 99-year-old billionaire, is not one to mince words. During the past weekend, he is quoted as saying “that the company’s success (Berkshire Hathaway) was by and large the result of low-interest rates, low equity values, ample opportunities,” suggesting that he lived during “a perfect period to be a common stock investor.” I’d add to that list investors of bonds, real estate, private equity, private debt, and any other financial instrument that was supported by a nearly 4-decade tailwind that often resembled a tornado!

Charlie also went on to say that “investment managers are nothing more than fortune tellers or astrologers who are dragging money out of their client’s accounts.” Harsh, but probably in many cases true. I’ve written on numerous occasions that the significant tailwind of falling rates and low inflation witnessed during the last 40 years has made us all appear smarter than we really were or are. This next rate cycle is going to help identify the real investors. Investors can hope all they want that the Fed will soon come to its collective senses, but in the meantime, employment remains firm and inflation sticky.

You can continue to ride the asset allocation rollercoaster to ruin or you can take substantial risk off the table by focusing on the promise that has been made to the plan participant. I know what I’d do.

2 thoughts on “Doesn’t the Starting Point Matter?

  1. Love your wisdom! Unfortunately I’m unable to log in to WordPress so this is the only way I can comment.

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