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There is a widespread
belief that the U.S. Federal Reserve remains on track to boost interest
rates back towards more "neutral" levels. The only question
is: what is neutral?
To
figure that out, it makes sense to look at what has been the norm over
several decades. Not only for nominal interest rates, but for
inflation-adjusted -- or "real" -- interest rates, too.
As it
happens, the median monthly nominal and real effective federal funds
rate during the past 50 years has been 5.31% and 1.76%, respectively,
while comparable yields on 10-year Treasury bonds have been 6.31% and
2.65%. The monthly year-on-year gain in consumer prices has averaged out
to 3.30%.
Under
the circumstances, one could argue that with February's 4.49% fed funds
rate lying 82 basis points beneath the median -- and the 0.89%
inflation-adjusted rate 87 basis points shy of its average -- we should
be looking for at least three more 25-basis point hikes.
Moreover,
with February's 4.57% 10-year Treasury yield 174 basis points below
normal -- and the real rate of 0.97% a similarly wide 168 shy of its
50-year median -- we should expect to see much higher bond yields -- and
sharply lower prices -- than we have now.
Not to
mention the fact that if reported inflation turns out to be understated
-- as many now believe -- the rate rises to come are likely to be far
more dramatic.
Whatever
the case, it seems wrong to assume that the 25-basis point rate hike set
to occur at next Tuesday’s FOMC meeting will be the last -- as bullish
proponents of the so-called "one-and-done" perspective have
been arguing.
Or
that the sell-off in bonds, which has boosted longer-term yields by
around 40 basis points over the past two months, will be ending any time
soon.
So
much for the joy of neutrality?
© 2006 Michael J. Panzner
Editorial Archive
Michael
Panzner is author of The
New Laws of the Stock Market Jungle: An Insider’s Guide to
Successful Investing in a Changing World
and a 20-year veteran of the stock, bond and currency markets. He
is currently at work on a book about global financial risks.
Contact
Information
Michael
J. Panzner
P.O. Box 115
Manhasset, NY 11030
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