Speculation over when the Federal Reserve will raise interest rates has been elevated to Super Bowl status by the financial media.
Just as sports writers dwell on field conditions, injuries and utterances by coaches, Fed observers rehash every conceivable economic indicator and report breathlessly on the comments of officials.
Absent from the analysis, unfortunately, is common sense.
The U.S. economy is growing, but tepidly. Wages are barely rising. The overseas engine driving global expansion – China – is struggling. Emerging-market currencies are falling.
In short, conditions that normally compel a rate hike simply don’t exist.
Compulsion to raise rates
But interest rates have hovered near zero for a decade, so the Fed’s itch to normalize rates is understandable. While it declined to do so earlier this month, Chairman Janet Yellen reiterated last week that rates will likely rise by the end of the year. In a speech at the University of Massachusetts Amherst, she cited certain conditions as being temporary, such as low energy and import prices, which she said have constrained inflation, and feels “headwinds” to growth “will continue to fade.”
As municipal bond investors, such talk would normally give us pause. Perspective, however, has taught us to focus on what’s really important.
Bond investors focus
We don’t agree that the factors Yellen cites as hindering inflation are temporary. The case she laid out recently echoes thoughts she’s expressed several other times this year. Clearly, the Fed is reticent to move.
If, after more than a year of public consternation and debate, the Fed does raise rates a quarter point, it’s unlikely a harbinger of a steady stream of hikes. In fact, such a move is more likely to hinder the economy and handicap growth. What’s more, the Fed only controls the shortest of interest rates (see: “The Media’s Interest-Rate Myth”). Long-term rates are determined by investors’ expectations of future inflation.
Municipal bond investors should ignore the Fed speculation. Predicting its actions is as futile as guessing the winner of a football game, but a lot less fun.
At a time when 30-year Treasuries are yielding a taxable 2.9%, we recommend investors savor the 4.00% tax-free yields available on today’s high-quality munis. That’s where the value is, not in the spectacle that Fed watching has become.
