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Posted by on Apr 7, 2017 in Crossing Wall Street, Market Insight

Crossing Wall Street Review – April 7, 2017

Crossing Wall Street Review – April 7, 2017

By Eddy Elfenbein, editor of  Crossing Wall Street and portfolio manager of the AdvisorShares Focused Equity ETF (NYSE Arca: CWS)

 
On Wednesday, the Federal Reserve released the minutes from last month’s policy meeting. This is the one where the Fed decided once again to raise interest rates. This was a notable increase, because it wasn’t foreseen a month beforehand. By the time it happened, it wasn’t a surprise. But for those key weeks, the expectations completely changed. I think Wall Street was surprised by how forceful and direct the Yellen Fed could be.

The Fed has become pretty good at conveying its intentions to Wall Street. But that’s regarding interest rates. What about the Fed’s balance sheet? Before the world economy went kablooey nine years ago, the Fed’s balance was less than $1 trillion. Then the Fed got busy. Very, very busy. Today, the balance sheet is $4.5 trillion.

As you might expect, this is a wee bit disconcerting for investors and folks inside the government. The problem is that if the Fed moves too quickly and dumps its holdings, that could cause long-term interest rates to rise. The Fed has been reinvesting the proceeds of its securities, but that could end soon. According to the minutes from the March meeting, “Provided that the economy continued to perform about as expected, most participants anticipated that gradual increases in the federal funds rate would continue and judged that a change to the Committee’s reinvestment policy would likely be appropriate later this year.”

As always, I apologize for quoting Fed officials. Despite their dull writing, this is actually a big, honking deal. First off, let’s make the important point that the Fed will keep using interest-rate adjustments as its main policy tool. For its balance sheet, almost certainly, the plan will be to deflate it slowly and quietly. We don’t want a repeat of Wall Street’s “Taper Tantrum” in 2013. My guess is that the first step will be a decision to end reinvestment of agency debt, not Treasury debt.

As we know, the bond market is notoriously ornery. Yes, they’ll scream and holler every step of the way. But ultimately, I doubt the Fed’s plans will have a sizeable impact on long-term rates. There’s simply too much demand from investors all over the world to hold U.S. debt. Plus, there’s no hurry for the Fed to lower its holdings. If need be, they can wait out a storm.

Instead, my fear is that the Fed will raise rates too much too fast. Looking at the data, there’s not a great need for higher rates. Later today, we’ll get the jobs report for March. We’ll see more job gains. I hope we’ll see more improvement in wages, but we have a long way to go. Inflation is still not a problem. While oil has moved up recently, it’s down for the year.

Eric Rosengren, the top dog at the Boston Fed, recently said he thinks the Fed needs four hikes this year. I’m sorry, but I just don’t get it. Maybe one more raise this year. Outside chance of two more. The problem, of course, is just because it’s a bad idea doesn’t mean the Fed won’t do it.

In the last year, long-term rates have gapped up significantly, and I’m starting to question how much of that is truly justified. I wouldn’t be surprised to see the yield on the 10-year Treasury fall back below 2%. Of course, much of this outlook is dependent on where the economy goes from here. Very soon, we’re going to get a slew of earnings reports. Let’s take a closer look at what Q1 earnings season has in store.
 

The information, statements, views, and opinions included in this publication are based on sources (both internal and external sources) considered to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Such information, statements, views and opinions are expressed as of the date of publication, are subject to change without further notice and do not constitute a solicitation for the purchase or sale of any investment referenced in the publication.

The AlphaBaskets blog provides frequent market insight and commentary by AdvisorShares Investments, LLC, created by AdvisorShares and other leading active managers.  AdvisorShares Investments is an SEC-registered investment adviser and the investment adviser to the AdvisorShares actively managed ETFs. The views expressed on AlphaBaskets should not be taken as investment advice or a recommendation for any of the actively managed ETFs advised by AdvisorShares.

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