It’s fun to imagine the late Yankees great Yogi Berra as head of the Federal Reserve, and policy-makers seemed to be following a famous Yogi-ism when they declined to raise interest rates Sept. 17 despite unemployment having fallen below the threshold it previously set for “liftoff.”
“When you come to a fork in the road,” Berra once advised, “take it.”
Before an outbreak of volatility in August, the Fed was expected to take the road to higher rates at its September meeting. Instead, the central bank went off in two directions, telling investors that rate increases were still on the near-term horizon while warning that a risky slowdown in global economic growth warranted staying on the easy-money path.
Usually, keeping rates lower for longer is bullish for stocks. Not this time. Investors were confused by Fed chair Janet Yellen’s dual message and unnerved by her dovish comments.
In effect, investors wonder if Yellen and the Fed know something they don’t.
That’s on top of what some investors already know: that emerging markets are teetering on the edge of a major crisis. Two of the four so-called BRIC countries — Brazil and Russia —are in recession, and more alarmingly, China could be headed for a hard landing as well.
The looming crisis in emerging markets is an unintended consequence of the Fed’s own ultra-loose monetary policy since 2008, which besides 0% interest rates include several rounds of bond buying. But because domestic loan demand remained sluggish, the cheap credit flowed into energy companies and emerging markets, creating excess capacity and high leverage.
With the Fed keen to begin normalizing policy rates, the resulting 15% rise in the dollar over the last year pushed up the cost of debt service for countries with dollar-based loans.
The timing could not have been worse.
Commodity revenues, the economic lifeblood for some key emerging markets, have fallen off a cliff. With money flowing out rather than in, a trade-weighted basket of emerging market currencies is at a 13-year low vs. the dollar.
Tequila sunset
Against that backdrop, even a modest Fed rate increase now could trigger a broader rerun of the so-called Tequila Crisis of 1994-’95.
To heal the financial industry in the wake of widespread savings and loan bankruptcies in the late 1980s, the Fed slashed benchmark interest rates from 9% to 3%, then abruptly pushed them back up to 6% amid rising inflation over a 15-month period through April 1995.
But south of the border, the Mexican government faced a political crisis, an overvalued currency and large dollar-denominated debts, which proved unserviceable after a 50% devaluation of the peso. The Clinton administration and the International Monetary Fund ultimately came to the rescue, but Mexico still suffered a deep recession and hyperinflation.
Yellen & Co. surely studied that crisis — and a similar cycle of devaluations in Asia a few years later — and perhaps concluded that with consumer price rises still far under the Fed’s 2% target, the risks of higher rates outweighed the benefits of getting an early jump on inflation.
Especially, that is, since the world is a more interconnected place than it was 20 years ago. As a percentage of global output, trade has increased by about 50% over the last two decades.
There are concerns on the home front as well.
Cratering commodity prices have stressed the balance sheets of corporate borrowers in the energy sector. Roughly half of S&P 500 revenues now come from overseas, a number that would shrink if the dollar kept climbing. And while the headline jobless rate has dropped to a level that historically has signaled higher inflation ahead, wage growth remains lackluster.
It’s also likely that Yellen learned a sobering lesson from Japan, which failed to escape a quarter-century of economic malaise, in part because its central bank twice moved prematurely in raising interest rates.
Whatever the reasons — and there are probably several — it’s clear that the Fed now listens to the markets as intently as the markets listen to the Fed.
Even when it speaks in Yogi-isms.
Tom Saler is an author and freelance financial journalist in Madison. He can be reached at tomsaler.com.
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