The most dangerous and most comforting word to describe the market today is ‘accommodation’. The Fed’s monetary policy has been one of sheer accommodation for the last 9 years. Accommodation has been needed to save the country from ‘The Great Recession’ and likely prevented a depression. The Fed dropped rates from midway through 2007 to the end of 2008 and had held rates near zero until December of last year, when the overnight rate was increased 25bps. They indicated that they planned to raise rates four times this year and ultimately put an expiration date on all of these years of accommodation. Yet here we stand with only three meetings left in 2016 and it is not clear whether or not the Fed will raise rates even once. Today the market prices the chance of one raise this year at 38%; two raises at 7%. Only a 45% chance of any movement upward in rates until 2017. Does the economy today warrant the need for such low rates?
The continued accommodation certainly has galvanized two sets of opinions. One camp suggests bond prices are too low and don’t compensate investors for the risk they are taking should inflation or rates move higher. The other camp believes rates could remain near historic lows for another decade and there is minimal risk. Will accommodation continue and will it be as pronounced as it is today? That is the billion or trillion dollar question. Is accommodation needed and if so, how much?
According to the payroll report from last week, one might assume accommodation would be headed for the exit. Non-farm payrolls came in at 255k for July versus 180k expected and June was revised upward from 287k to 292k. June’s strong print no longer appears to be an outlier and the job market seems to have some footing. Inflation data is due later this week that could offset some of the positive job news or it could make the further case for a Fed tightening, possibly in September. Or can they make any change to interest rates given what’s happening around the world? See below for changes in yields from a few developed nations and make your own opinion on what they Fed can and cannot do with US rates. The market certainly has given its opinion and called the Fed on their bluff several times now. My only caution is that the removal of accommodation would be a shock to the system and thankfully the Fed is aware of that.