September 16, 2022
That was quite a week. We're too exhausted to even check our 401(k) balances, which have taken a beating due to the shift in the interest rate outlook explained below.
- Plus, we examine the question: What has Janet Yellen done for you, philately? (Less than her past press coverage might imply). 📬
Today's newsletter, edited by Javier E. David and copy edited by Katie Lewis, is 701 words, a 2½-minute read.
1 big thing: The end of the ZIRP as we know it
With monetary policy, what matters most is the destination, not the journey. What ultimately shapes the economy and markets is not a central bank's tactical moves, but how much it eventually raises interest rates.
- Now, a seismic shift is underway in the outlook for the so-called terminal rate of this tightening cycle.
Driving the news: Since a high inflation reading Tuesday, expectations have grown that the Fed will end up hiking much higher than seemed likely a week ago. It's causing stock prices to tumble and the odds of a recession to rise.
Why it matters: If the outlook rapidly being priced into markets becomes a reality, it marks the end of an era in which rates seemed perpetually locked near zero.
- Just maybe, ZIRP (zero interest rate policy) is no more. That, at least, is now priced into the bond market, with one-year Treasurys now yielding more than 4%, the highest since 2007.
By the numbers: A week ago, for example, futures markets priced in less than 1% odds that the Fed's target rate will be above 4.5% by February. Now those odds have risen to 36%, according to the CME Group's calculations.
- In a mechanical sense, higher interest rates make each dollar of future earnings worth less today. That helps explain why the S&P 500 is down 7% since Monday's close (as of 10am EDT today).
The mainstream view is that the Fed's target rate will reach the ballpark of 4% at the end of this year. That rate is currently just under 2.5%. Some commentators now see a rate target near 5%, or something close to it, as likely.
What they're saying: Economists at Deutsche Bank analyzed the potential endpoint for the Fed's target rate using a few different approaches and found they all "suggest that a fed funds rate at or around 4.5% could be required by early next year."
- But chief U.S. economist Matthew Luzzetti and three colleagues argued in a research note published yesterday that, "accounting for risk management considerations, a rate approaching 5% is likely to be needed."
That seemingly small difference has massive implications for financial assets.
- Ray Dalio, the founder of massive hedge fund Bridgewater, argued in a LinkedIn post that if the Fed ends up pushing rates to 4.5%, it implies a 20% decline in stock prices because of the higher discount rate for future earnings, as well as lower incomes.
What's next: Following its policy meeting next week, Fed officials will release new forecasts of, among other things, their own expectations for the path of interest rates.
- In June, the median official thought rates would top out at 3.8% at the end of next year; on Wednesday, we find out whether they've upwardly revised those forecasts.
2. Janet Yellen doesn't really collect stamps
The Wall Street Journal has a delightful story about how Treasury Secretary Janet Yellen is often gifted rare stamps by the many foreign leaders she meets with. As befits an avid stamp collector.
The problem: She doesn't actually collect stamps, at least not in any deliberate way. It seems to be a bit of an urban legend that (confession time) one of your Macro co-authors may have played a role in propagating.
- "Stamps really don't mean anything to Janet at all," her brother John Yellen told the Journal.
The backstory: Yellen's mother left behind a stamp collection when she died in 1986. When Yellen entered public service in the 1990s, she dutifully entered an estimated value of the collection in her financial disclosure forms ($15,000 to $50,000), which ended up being noted in press coverage over the years.
- That includes this piece Neil wrote for the Washington Post in 2013, a simpler era when goofy blog posts about financial disclosure forms were all the rage.
- A Seattle Times headline that year called Yellen "a consensus-building stamp collector."
- And a Post article led with the stamp-collecting trope in a profile of Yellen just last year.
In our defense: Sometimes when writing about economic policymakers, one has to stretch to find colorful nuggets of personality.
- But John Yellen told the Journal that Yellen's stamp collection is probably just sitting around in a safe-deposit box somewhere, waiting to be passed along to the next generation one day.