Having been in and around the investment business for many years, and witnessing more than a few interest rate cycles, the one thing that struck me, at least under Alan Greenspan’s leadership and then seemingly followed by Ben Bernanke, is that the Federal Reserve Chair and the FOMC rarely “lead” or anticipate markets: my recollection of all the interest rate moves up to and including the 20 years from 1990, through ZIRP, is that the FOMC follows economic events, and reacts accordingly.
I don’t know that that necessarily implies a prediction for this Thursday’s FOMC meeting, but it is really more for readers edification, and contemplation than anything.
Let’s look at the tape:
1990: The commercial real estate crisis (and the high yield debt bubble) of the late 1980’s which led to the creation of the RTC (Resolution Trust Corporation) and was a considerable drag on US economic growth, which necessitated a gradual reduction in fed funds from over 7% to 3% by Alan Greenspan, following the start of the first Gulf War and through 1993. Most pundits and investors don’t realize that there were more banks that went under during the commercial real estate crisis than collapsed during 2008 – 2009. Greenspan and the FOMC consistently reduced the fed funds rate 25 bp’s at a time over a 3 year stretch, culminating in February 1994’s reversal. The SP 500 embarked on a monster rally from the start of the Gulf War and invasion of Kuwait, and the rally lasted more or less for 4 years. (I remember writing economic commentary for a small Chicago brokerage firm and was in the office on what I remember was a Sunday night, 10 pm., mid-January, 1991, when the US started bombing Baghdad, then carried live on CNN. Equity futures rocketed higher as did Treasury prices in overnight markets, catching many leaning the wrong way.)
1994: It was the Q4 1993 GDP data, released in late January ’94 that got Greenspan’s attention, (the 30-year Treasury yield had bottomed near 5.75% in October, ’93 and had been gradually rising over that 4 – 5 months), whereby the FOMC raised the fed funds rate 6 times in 1994, starting in the first week of February ’94. (The initial tightening during the first week of 1994 was not a regularly-scheduled FOMC meeting either, but I thought Greenspan convened the FOMC by telephone. The Maestro was really frightened by that GDP number. The 1994 tightening cycle culminated in the Orange County IO/PO (mortgage derivative) disaster and the peso devaluation.
The Fed funds rate was 5.5% by the end of 1994, and what is interesting to me (in the 2nd link) was how Greenspan tried to “fine tune” the fed funds rate changes in early 1995, both raising the rate to 6% and then reducing it, fearing 1994’s tightening’s may have been too extreme. The SP 500 rose 37% in 1995 – it was a another monster year for equity returns for all the indices, with 1995 the start of the large-cap tech and growth blow-off culminating in March, 2000.
1998: The next major fed funds move started with the Long-Term Capital Crisis in October, 1998 (David Faber of CNBC, with some great reporting, broke the story on what was happening within Long-Term Capital Management), since investors were wondering why the SP 500 was absolutely getting crushed in August – September, 1998. The FOMC didn’t actually move until October, 1998, when Greenspan become worried about the widening differential Treasuries and corporate credit spreads. It was this Treasury – corporate bond spread disconnect, and its liquidity implications, that led to LTCM’s collapse, according to Eric Rosenberg, one of LTCM’s more highly regarded traders at the time, as he detailed afterwards. The Thai Baht and Malaysian ringghit devaluations and the collapse of most of the SouthEast Asian Tiger economies starting in July, 1997, cascaded and culminated in LTCM’s collapse in late 1998. It was really an ugly time: for readers edification, Wall Street at the time, which was still populated Lehman, Bear Stearns, Morgan, and Goldman, etc.etc., all had copied the trading book of LTCM given its winning ways, and then in effect Chairman Greenspan had to ask the banking system to bail out Wall Street, after Street had bailed out the banking system in the early 1990’s.
Up until now, it is clear that Greenspan would only move when prompted by the data. Like Mel Gibson in Braveheart, Gman typically held his ground and then moved aggressively after sufficient evidence.
Now we move in the late 1990’s, the so-called tech bubble, Y2K (remember Y2K, the most overhyped non event Al Capone’s vault was uncovered in Chicago ?), and 9/11.
December, 2000: After March, 2000, and then as late December, 2000 after Intel’s earnings warning in September, 2000, the Nasdaq was coming apart rapidly. I remember Jack Welch, just departed from GE, beating up Greenspan publicly in Q4, 2000 saying that the US economy was slowing rapidly, and the Fed was ignoring it. Greenspan and the FOMC stayed pat at the December, 2000 meeting.
January, 2001: Greenspan finally reduces the fed funds rate, the Nasdaq and the SP 500 rally for the month of January, and that was it, until 9/11/2001. A lot of hot shade was directed Greenspan’s way in late, 2000, early, 2001, but of course no one knew what was coming on September 11th, 2001.
The easing after 9/11 was certainly understandable, not just from an economic perspective, but from the physical damage to what was (I thought) the US banking system’s transfer payments mechanism. Here is an interesting link on what Roger Ferguson faced that day, with the requisite cheap shot directed at President Bush. However, I think the story gives readers a good perspective of what the Fed was faced with on 9.11, just from a logistical perspective.
Think about the tremendous liquidity floating around the mortgage and auto credit markets post 9/11 (understandably so), and how that culminated in 2007 – 2008.
2003 – 2006: Greenspan and the FOMC kept the funds rate near 1% through 2003 and then in 2004 started to tighten monetary policy again. Greenspan and the FOMC took the fed funds rate back to 5.25% as of late, 2006, only to be faced with “The Conundrum” or the fact that the FOMC and the Maestro were raising short-term rates, and the 10-year and 30-year Treasury yields weren’t following suit.
In effect, the Treasury yield curve faced a dramatic flattening during this time, as I recall.
Part of this was likely the result of the tremendous bearish sentiment around Treasuries at that time: CNBC’s Rick Santelli did a JP Morgan sentiment survey every Tuesday morning from the floor of the CME / CBOT, and routinely the buy and sell-side portfolio managers were expecting higher Treasury yields to the tune of 80% / 90% to 10% / 20%.
2007 – 2008: This sentiment stayed like this for for years, until 2007 – 2008.
The SP 500 peaked in October, 2007 near its March, 2000 high of 1,550 (the SP 500 peaked at 1,576.09 in October ’07) and it came apart from there.
Greenspan and the FOMC started to get worried in September ’07, when Bear Stearn’s hedge funds started having liquidity issues. The FOMC started reducing the fed funds rate 50 bp’s in September ’07 and never looked back. One wild and not readily understood aspect of late 2007, well before the collapse of Bear Stearns and Lehman, was that basically all the profits of the US banking system were wiped out Q4 ’07, thanks to write-downs at major banks.
Most readers know what happened to Bear and Lehman and so the rest is history.
By late 2008, the fed funds rate has been at zero and it hasn’t been changed since.
No one in my generation would call a 0% fed funds rate “normal” but that is what we have today.
Implications for this week’s FOMC announcement: After writing this out, I now think Yellen and FOMC will not lift fed funds 25 bp’s on Wednesday – Thursday of this week. Writing this out (and readers probably found this history horribly boring), it is clear that – unless there is some exogenous event – the FOMC and the Chair have a history of waiting for irrefutable evidence. despite the 5.1% unemployment rate today, there is little wage inflation, or any other inflation for that matter. Historically, it seems like the FOMC would rather be late and “sure” than anticipatory and change the fortunes of the market.
My own opinion is that the FOMC can wait 3 months to see if the unemployment rate drops to 4.9% by the December ’15 meeting – at that level, the FOMC would have a powerful motive to start to tighten monetary policy.
Then again, I have no more insight than any other whac-a-mole around the business. Sentiment remains very bearish around Treasuries (still), 10 years after the Fed’s last tightening cycle.