Before we can call the economy “good”, we have to be in a situation where good news is taken as unvarnished good news. And that seems to have finally happened.
Janet Yellen outlined in great detail exactly why interest rates not only have to start rising by the end of the year, but why they have to go up to around 2% before the Fed is done. The market responded positively, getting another shot of good news this morning. Has the monkey of cheap money finally been scraped off their backs?
In a speech at the University of Massachusetts Yellen laid out the case for higher rates. While employment has improved, far too many people are working part-time even though they want more hours. But inflation is likely to return and the Fed’s target of 2% inflation is likely to be met within two years. That requires a rise in the Fed Funds Rate now in order to gradually go all the way to 2% for the purpose of keeping inflation at bay.
Her remarks were punctuated by data released this morning showing that in 2Q15 the economy expanded by a very robust 3.9%, better than the 3.7% initial estimate. It did this on the back of strong consumer spending data which expanded at 3.6%. This was the missing piece of the puzzle, the last thing to finally rebound from 2008.
Since about 2011, good news like this has been taken as bad news on Wall Street. The thinking went that if the Fed had to raise rates the underlying support for the stock market would be in danger. Confidence in the economy itself was low – everything depended on cheap money.
That’s how good news became bad news – an addiction to low interest rates.
Wall Street is instead responding to the good news on consumer spending, which is to say that we have a real economy for the first time in about nine years. The cool confidence of Fed Chair Yellen has apparently also helped. This is all good.
That’s not to say that there aren’t problems ahead. The rest of the world is clearly cooling off at the same time the US is running strong, which almost has to hurt exports. The Volatility Index (VIX) still runs about 20, meaning there is a 66% chance the market will go up or down 20% in the next year. If there was real confidence in the market that would be down around 10. Gold has also briefly spiked above $1,150 per ounce, but that probably will not hold for long.
But for all the talk about interest rates, they are actually falling. Today’s rally in stocks has not made any change in the 10yr Treasury Bill, which is a better indicator of the interest rates consumers will have to pay. As investors sold stocks they bought more of these in a “flight to quality”, trying to keep their money safe. The 10yr stands at 2.17%, down from a peak near 2.4% earlier this year.
It still remains to be seen if a rise in the Fed Funds Rate actually has a net lowering effect on interest rates overall as more investors continue to buy 10yr treasuries, driving the rate down. That will take a lot more interest from other nations as the once cheap money comes home, primarily from developing nations. This is the most important thing to watch in October.
No matter what, however, we are entering a time where good news is good news. The bizarro economy of the last few years is finally ending. The firm hand of Janet Yellen is inspiring confidence, as it should, and a net rise in the Fed Funds Rate is not scaring anyone.
Perhaps we can get on with gettin’ on, developing an economy based on making things and selling them to consumers rather than one based on pushing money around. That’s what we really need, and paradoxically a rise in interest rates is only likely to make that more likely as quick, cheap deals are harder to come by. It may seem crazy to say that higher rates are the friend of the working person, but that is likely to be the case for the next year or two.
Yellen made that case and Wall Street cheered. In the next few months we’ll see how much everyone is cheering the decision as we watch the job market and the 10yr bond.