The Interest Rate Dilemma

The interest rate dilemma
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Each year in our summer issue, we ask a group of the region’s leading wealth managers to help our readers navigate financial waters by responding to a question. Their answers follow in reverse alphabetical order. If you were the Federal Reserve Board Chair, when and how would you raise interest rates (if at all), and why?

Alison Wertz
Bill Few Associates

I would start raising interest rates sooner rather than later (36 months), but slower rather than faster (1525 basis points per quarter). The previous six years of unprecedented monetary policy have created a level of uncertainty that has restrained entrepreneurial risk taking, investment and innovation, inadvertently stifling the growth engine of our economy. Any step towards a more “normal” monetary policy, regardless of how small, will have the short-​term impact of disrupting markets. However, the more lasting impact will be a restoration of confidence and the signal that it is time to get back to business. The funny thing is that when we look back on this a few years from now, we will probably wonder what all the fretting was about.

Brian Werner
First Niagara Wealth Management

I would consider meeting the market’s expectation by raising rates by the time of the September meeting. One thing we know for certain is that the market does not like surprises. As an investment manager, I would like to return to an environment where we seek the interpretation of true fundamental economic data as opposed to Fed minutes serving as a proxy for economic data. However, the more pressing question I ask myself is not “when” and “why” rates rise, but how the pace of the Fed’s tightening policy might affect both stock and bond markets. Further, we must assess how to appropriately position portfolios in front of rising rates. We need to consider both the upside and downside of a change in Fed policy.

Tom Wentling
UBS Financial Services

It is undeniable that the Fed averted catastrophe during the financial crisis. Reasonable people can differ about how long the “safety net” should have remained. Interest rates act to allocate capital to its most productive use. Six years into a recovery, a strong case can be made to let market forces determine where capital should flow. Our economy is arguably the most stable in the world. We have problems, but they pale in comparison to other countries, which our markets and the dollar reflect. It boils down to this: Are you a bandage “ripper-offer”or a “hair-​by-​hairer?” Fed watching is inscrutable by design (“data dependent” is latitude friendly). UBS currently forecasts the first rate increase in September (year-​end 0.625 percent, current 0.25 percent). Personally, I’m an “all-​at-​oncer.”

Jeff Wagner
F.N.B. Wealth Management

The first increase in the federal funds rate will be more of a message than an economic event. The Federal Reserve will be indicating that the U.S. economy has reached a point where less Fed “accommodation” is needed. Based on the improved employment numbers and some early signs of increasing wages, we feel that this initial move is warranted. Barring some major negative economic event, we expect this move sometime in 2015. In the short term, the stock market may react negatively to the first increase in short-​term rates in six years. However, we feel that rates slightly above zero will not adversely impact the economy, and we firmly believe future rate increases will be kept in check until rising inflation becomes a trend.

Andre Voicu
Fragasso Financial Advisors

The Federal Reserve seems eager to normalize its monetary policy. At the last Fed meeting, most Federal Open Market Committee members believed rates should increase to 0.625 percent by year end. Raising rates may prove to be premature. While the Fed is on a tightening path, the other major central banks, the European Central Bank and the Bank of Japan are in full-​blown quantitative easing mode. The sharp divergence in policy was immediately felt in the currency markets as the U.S. dollar rallied. The dollar strength combined with the low oil prices are strong deflationary forces. With no inflation, why raise rates? The only reason seems to be getting some ammunition for the next recession. If I were Janet Yellen, I’d worry about actually triggering a recession while getting the ammunition to fight it.

Megan Petruska
McMahon Financial Advisors, LLC

Unless the economy really picks up sharply or wages begin to rise quickly, we believe that a rate hike is more likely to take place in the second half of the year than at the June meeting. The Fed is sending the signal to the markets that they are on the path to raising interest rates, but they are not in a big hurry. The members of the Fed Open Market Committee are still looking for reasonable confidence that the positive trends in the economy will continue and that the Fed Funds Rate will reach its 2 percent target by year-​end 2016.

Ron Muhlenkamp
Muhlenkamp and Company

The Fed’s mandate is for price stability and maximum employment. Fearing deflation, the Fed has set a target of 2 percent inflation (not price stability of near-​zero inflation). And, with labor participation at the lowest it’s been since the 1970s, the Fed also fears that market-​determined interest rates would cost jobs. Six years into this experiment, the Fed points to higher stock market prices to justify keeping interest rates low — but increasing stock prices should not be their goal. We’ve seen what happens when stock prices get ahead of the economy reality: bubbles in 2000 (dot-​com) and 2007 (housing). It’s time to unwind this experiment. If I had Janet Yellen’s job, I would allow interest rates to move toward their market level, beginning now.

Mark Luschini
Janney Montgomery Scott

I would be eager to move away from a crisis-​induced zero bound interest rate setting and restore some policy flexibility for the future. However, I would only begin to raise rates if the prevailing economic data were sufficiently strong to withstand a potentially adverse reaction by the financial markets, and/​or an incremental increase in borrowing costs. I would also host some concern that increasing rates would further boost the dollar, which has already acted as de facto tightening and stunted corporate profit growth. Since I think the economy will be sturdy enough and is evidencing signs of further positive momentum, it is likely that we will see liftoff this fall. That announcement will probably be accompanied by the prospect of further rate increases, the size or frequency of which will be open-​ended.

Jack Kraus
Allegheny Financial Group

The Fed Funds rate has been at the current target of 0 to 0.25 percent since Dec. 16, 2008. Now, Janet Yellen and the other Fed governors are faced with the prospect of increasing interest rates. The zero rate policy is great for those who borrow money, but has been incredibly hard for those who save money. Janet Yellen should move very slowly and very transparently as not to shock the markets. There is no need to drastically increase rates, since inflation is tame currently. The Fed should take baby steps and be flexible to continue increasing rates or decreasing them as needed. The Fed should aim to get rates equal to the core inflation rate at a minimum.

Bob Kopf
Smithfield Trust Company

In my opinion, the Federal Reserve is probing the outer limits of what can be achieved with a policy of extreme monetary ease. Almost six years after the 2008-​09 recession ended, the Fed’s policy interest rate — the Fed Funds Rate — is still close to zero, even though the unemployment rate has been reduced from 10 percent in 2009 to the latest reading of 5.5 percent. Keeping the Funds Rate at near zero is risking another upheaval in the financial markets. The U.S. economy is strong enough to permit the Fed to raise the Fed Funds Rate to the 1 percent zone by early next year without posing a threat to the economic expansion.

Dean Kartsonas
Shorebridge Wealth Management

The Fed’s mission is to manage economic growth by keeping an eye on the labor market and inflation. Simply put, the economic expansion over the last six years has been modest and the Fed should maintain its zero interest rate policy for the foreseeable future. Since the great recession of 2008, most measurements of the U.S. economy have underperformed both past historical periods and current expectations. A few of these statistics would be GDP growth, employment, wage gains, new and existing home sales and inflation. The advocates for a quick rate hike point to fears of future inflation, financial market distortions and lack of flexibility for the Fed to handle future crisis. The Fed’s aggressive policy is unprecedented and will likely need to normalize eventually, but that will have to wait on stronger economic growth.

Stuart Hoffman
PNC Financial Services Group

The economy started 2015 on a soft note, with real GDP growing slowly. PNC expects a strong rebound in real GDP growth and jobs pushing the unemployment rate lower and stable inflation in the middle two quarters of this year. Fed Chair Janet Yellen and her colleagues should wait for confirmation of faster economic and job growth and faster worker compensation gains before starting a very gradual rise in the Federal funds target rate at their September 2015 meeting. At that time, the correct “diagnosis” will be that Fed policy is awakening from a self-​induced, long coma in response to improving vital signs for the U.S. economy and, particularly, the labor market. Those of us “loved ones” of a living monetary policy responding to a healthier economy should rejoice, not be fearful.

Elizabeth Genter
Schenley Capital

We would raise rates in the first quarter of 2016. We have experienced a close-​to-​zero rate environment for six years, and the stock market has benefitted greatly. However, the economy, in spite of some improvement, is still not working on all four cylinders, and it is time for change. Higher rates should produce higher corporate profits and thus reduce underemployment — not by merely reducing unemployment, but also (and equally as important) by creating a demand for the better-​paying jobs that the economy has failed to produce. The adverse side effect of a raise in rates may be a further increase in the value of the dollar. However, it is our belief that the expectation of this raise has already been reflected in today’s markets. We are focusing our efforts in Europe, emerging markets, and in Japan.

Daniel B. Ellwood
Wesbanco Trust and Financial Services

Despite the recent weakness in the U.S. economy, we expect that growth will remain on track, a result of unprecedented monetary policy support. The economy should again strengthen, providing evidence that it has indeed reached a point of being self-​sustainable. However, this period of weakness may give Fed officials a reason to delay the start date for increasing the Federal Funds rate. The Fed should begin the process by the end of the third quarter of 2015 and, as data allows, continuing until the Federal Reserve estimates for short-​term rates are in sync with market expectations. Do not expect rate increases to occur at every meeting. Even after the process has begun it will be some time before we will be able to characterize the Fed as restrictive.

Linda Duessel
Federated Investors

If i were Janet Yellen, I would nudge up rates starting this year — we’re not in an emergency situation like we were when we took rates to zero in late 2008. The unemployment rate has been nearly halved. Jobs are expanding at their fastest pace since the 1990s. Corporate profits and the equity markets have been very good. At the same time, record low global bond yields, miserly wage growth and below-​trend inflation make it hard to justify a big move up. To put a number on it, let’s say one and done, i.e., I’d gradually get us to a 1 percent target rate and assess the situation. And I would be as transparent and flexible as possible about my actions all along the way.

Greg Curtis
Greycourt & Co.

So long as the Fed continues to interfere with the normal functioning of the economy and markets, growth will remain anemic, labor force participation will shrink, and investors will continue to drown in risk. When central bankers manipulate interest rates at this extreme level (or use extreme monetary policies like Quantitative Easing) what happens is this: a) economic actors cannot plan intelligently (which is why American corporations are holding $5 trillion in cash instead of spending it on CAPEX), b) workers seeking jobs will find disappointment (which is why labor participation rates are down to less than 63 percent), and c) investors will take far greater risk than they can bear as they desperately seek yield (which is why we have bubble conditions in most equity markets).

Scott Cox
BNY Mellon Wealth Management

Why raise rates? The Fed has largely achieved its goal of bringing about significant improvement in the labor market, even though some problems remain. A zero interest rate policy is not normal or sustainable. Maintained too long, it can lead to major distortions in asset prices. Why have rates not been raised yet? Inflation rates in the U.S. have been quite low, uncomfortably close to deflation, which can be quite pernicious. The Fed is targeting 2 percent core inflation, but inflation has remained below that level. Also, the Fed wants to sustain moderate economic growth that isn’t cut off by a premature rise in rates. When? The September FOMC meeting seems reasonable for the first of what might be two 25-​basis-​point hikes before year-​end.

James McKay Armstrong
Henry H. Armstrong Associates

The Fed’s actions back in 2008 were necessary and appropriate in order to restore confidence and liquidity in the U.S. financial system. But those actions — which have held interest rates near zero for 6 years — have side effects. One side effect is that interest rates at zero punish the saver, and reward the borrower. As a nation, we want the contrary: we want to reward savers and limit borrowers. China’s high savings rate, and consequent industrial power, prove the value of savings. And a quick look at borrower behavior prior to 2008 proves the need to limit borrowers. If I were Janet Yellen, I would begin raising rates now, to begin to wean the economy from an unsustainable and unhealthy gusher of cheap credit.

PQ Staff

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