(James Saft is a Reuters columnist. The opinions expressed are
By James Saft
March 25 Now we know interest rates are rising
in the largest economy in the world: it isn't a question of
whether, or even so much when, only how fast.
Janet Yellen, in her first Federal Open Market Committee
press conference since taking over as chair, surprised investors
last week by suggesting that rates can be expected to rise six
months after the taper is completed and QE is done. That puts
liftoff, all things being equal, at April of 2015, several
months sooner than markets previously were anticipating.
Subsequent comments from Fed officials have been more about
how best to characterize the perception created by Yellen,
rather than clarifying or correcting it.
St Louis Fed President James Bullard said that six months
wasn't a change of policy, and was something the "private
sector" (which must somehow be distinct from financial markets)
was already anticipating. Narayana Kocherlakota, the president
of the Federal Reserve Bank of Minneapolis, denied the Fed was
being more hawkish while San Francisco Fed President John
Williams more or less said he'd not changed his view.
To be sure, the Fed will doubtless react to developments as
they occur on the ground, but it is hard to escape the
conclusion that, for one reason or another, it is now more
comfortable with the prospect of higher interest rates.
Financial markets now see about a 50 percent chance of an
April 2015 rate hike, up from only about a 32 percent chance a
The particularly interesting thing is that this new
willingness to raise interest rates hasn't been accompanied by
much evidence of an economic improvement, either in the data,
which remain at best mixed, or in the Fed's own forecasts, which
are mired more or less where they were in December.
That's bad news for risky assets like stocks or high-yield
debt. Broadly, it indicates that while there aren't
macro-economic reasons to expect a better earnings environment
for companies, there is a new-found chance of tighter financial
markets and higher interest rates.
That goes a long way towards explaining the weak tone
financial markets have taken since the Fed meeting, particularly
among sectors with the most stretched valuations, like high-tech
and biotech companies.
THE SECONDARY WHY
There is also, when it comes to rate hikes, a question of
secondary importance, and that is why.
Some noted that the pattern of predictions for the future
level of rates from FOMC members indicated that most of the
increased forecasts were from the dovish arm of the committee.
That could indicate that those Fed officials are now less
fearful about some of the more extreme risks that could
potentially face the economy, according to Stephen Jen, a hedge
fund manager at SLJ Macro Partners. That would justify a more
hawkish stance in the absence of strong evidence of improvement
in the economy.
It is hardly a declaration of victory, either for
quantitative easing or for zero interest rates. Instead it is
more an exhausted truce with a low-growth world in which those
two tools have more limited utility.
The most interesting, and potentially important, thing to
come out of the Fed in the past week is a speech by board of
governors member Jeremy Stein in which he argues that the risk
of overheating financial markets should play a bigger role in
how the U.S. central bank sets policy, even if it comes at the
expense of hitting employment goals.
"All else being equal, monetary policy should be less
accommodative - by which I mean that it should be willing to
tolerate a larger forecast shortfall of the path of the
unemployment rate from its full-employment level - when
estimates of risk premiums in the bond market are abnormally
low," Stein said on Friday.
Stein presented evidence that not only does monetary policy
affect risk premiums, something we've seen both recently and
before the last crash, but that the potential for violent or
sudden unwinding of overheated financial markets is not
compensated fully by better growth when tight conditions
That's an important acknowledgement that central banks can't
simply pour gas on the flames of financial markets and then
avert busts with prudent regulation.
While Stein was careful to say he wasn't arguing that
markets were now overheating, his thinking, about both
regulation and monetary policy, may be part of a new awareness
of the limits of central banking.
Janet Yellen's predecessors, Alan Greenspan and Ben
Bernanke, both won adulation for monetary policy heroism despite
a long-term record of boom, bust and now low growth.
Perhaps Yellen's signal achievement will be in restoring
realism. That's probably consistent with higher rates and lower
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be
an owner indirectly as an investor in a fund. You can email him
at email@example.com and find more columns at blogs.reuters.com/james-saft)
(Editing by James Dalgleish)