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Let’s pretend you were living in a bunker since January 2009 with no access to the outside world. You come out of the bunker in January 2018 and are presented with the following facts:
1) The U.S. economic expansion that began in June 2009 is now eight and a half years long, 102 months and counting.
Source: NBER, FRED, Pension Partners. Date Range: January 1949 – December 2017.
2) The U.S. Unemployment rate has moved from 10% in October 2009 to 4.1% in December 2017. This is its lowest level since 2000.
Source: FRED, Pension Partners. Date Range: January 1948 – December 2017.
3) Non-farm payrolls have been positive for 87 consecutive months, by far the longest streak in history (previous record was 48 months).
Source: FRED, Pension Partners. Date Range: January 1939 – December 2017.
Where would you expect the Federal Funds Rate to be?
If you said 4%, 5% or higher, you would be mistaken. Those would have all been good guesses given the historical precedent before 2009, but the period since then has been anything but normal.
The Federal Funds rate stands today in a range of 1.25% to 1.50%. To put that range in perspective, it is below the Fed Funds Rate at the time of the Lehman Brothers bankruptcy (2.00%), when the U.S. economy was in the midst of the worst recession since the Great Depression.
This is another way of saying the Federal Reserve has maintained emergency monetary policy for far longer than any period in history. Just how easy has this policy been?
One way to measure relative easiness is to take the Effective Federal Funds Rate over time and subtract Core CPI over the prior year. This normalizes for the level of inflation, as higher inflation warrants a higher Fed Funds Rate and vice versa.
If we take the current Effective Federal Funds Rate (1.4%) and compare it to Core Inflation (Consumer Price Index (CPI)) over the past year (1.7%), this leaves us with a real Fed Funds Rate of -0.30%. The real Fed Funds Rate has now been negative for 116 consecutive months. The prior record was only 39 months.
Where does that leave us today? In unchartered territory to say the least. The unprecedented easy monetary policy has led to an unprecedented boom in asset prices of all types: stocks, junk bonds, real estate, collectibles, etc., etc. Last year, that boom moved to the world of cryptocurrencies, where we witnessed one of the greatest manias of all time.
When will it end? Nobody knows, but market participants should be aware that if the Fed follows through with its plan to hike rates 3 more times in 2018, monetary policy in the U.S. will be moving closer to historical norms. And if monetary policy is moving closer to historical norms, asset prices could move in that direction as well. What does that mean in practical terms? More volatility, more corrections, and more opportunities for risk management strategies to stand out.
The end of easy money is not likely to go out with a whimper, but with a bang. When is the time to prepare for such a change? Before the bang.
Charlie Bilello is the Director of Research at Pension Partners, LLC, manager of the ATAC Inflation Rotation Fund (ATACX). He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. Charlie holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and also holds the Certified Public Accountant (CPA) certificate.
In 2017, Charlie was named the StockTwits Person of the Year. He is a frequent contributor to Yahoo Finance and has been interviewed on CNBC, Bloomberg, and Fox Business.
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