Fed Policy, Red Bull, and Buddha

Will the Fed raise interest rates? Will I gain one pound after eating the giant pork chop at Le Petit Cochon? Answer: Who cares? Apparently the market seems to care more about interest rates than my waistline. So let’s work on that question today.

Thanks to my friends at the St Louis Fed I was able to download a chart from their lovely FRED service. This graph charts an interest rate – the 10 Year Treasury Constant Maturity Rate (or let’s call it Ted). Ted tells you what you could earn on a riskless asset with a 10 year maturity. It also seems to be at the heart of something called the interest rate yield curve. I see some of you are dosing. So let’s try one more time – this graph of Ted shows you an interest rate that represents interest rates on all sorts of assets. Ted is like the popular guy you know. If Ted goes to the Player’s Pub then everyone goes there. If Ted goes to the IU Opera, then the crowd goes to see the Flying Dutchman (highly recommended for people suffering sleep deprivation).

The Fed does not directly control Ted. But smart people watch Ted to gauge how the Fed’s actions will affect all sorts of interest rates. I love the below graph of Ted. I could write about it until the cows come in even though I don’t even have one cow.

The graph shows Ted from well before 1970 to now. It shows how Ted behaved over a long period of time and over lots of short periods of time. It shows Ted before, during, and after recessions.

Ted got really heavy as a youngster and peaked out at around 15% in 1982. Then he went on a diet and has been losing ever since. Sure he falls off the Dick’s Burgers wagon now and then but he keeps getting svelter and svelter.

As a result of looking at this graph of Ted for at least 100 hours you can come away wondering if there is something called a normal interest rate for our times. Despite what the Fed might do or not do in the coming weeks, one story is the long-term trend since 1982 towards lower rates. Perhaps rates will go even lower for yet another phase of this trend?

Or you might say that the downward trend has to end sometime. Negative interest rates are possible but it seems strange to think of negative interest rates as the new normal. It would be like going into a Whole Foods and being told that they will pay you $10 to take home a dozen natural cage free no hormone no antibiotics Omega-3 Nest laid, vegetarian diet certified human raised and handled extra-large eggs.

So let’s ignore the trend. The other thing you might note is that Ted generally rises before recessions. These recession-inducing interest rate increases might have been a natural result of a rapidly growing economy or the direct result of an intended (or not intended) Fed policy. If you have on your reading glasses you can see the shaded vertical bars representing recessions and look at how many of those bars were preceded by a rising Ted. Aha – the culprit has been found and so the recession cure is right before our very eyes. Do not let the Fed push Ted up and we won’t get another recession!

Not so fast Nathan. If you squint and look even harder you can find a number of time periods in which Ted rose but did not lead to a recession. So now we have it – rising Ted causes recessions at times and does not cause recessions at other times.

This brings us back to our current dilemma. We are all waiting for the Fed’s decision as to whether they will raise interest rates another smidge in June or July or whenever. The second Rufus gets a whiff of a rumor of such an interest rate increase, Rufus calls in the dogs and the markets go crazy. But seriously, what is wrong with these markets? 

Looking at the chart, have you noticed how low interest rates are? Are we really serious that another 15-25 basis point increase is going to throw us into a tizzy? Whatever that policy might do to Fred in coming months its value will still remain on such a low portion of the graph that you can hardly see the increase.  Imagine how people felt when the Fed engineered the 15% rate in the early 1980s? Now that increase was noticeable!

Graphs and data do not prove anything. But they sure have a way of putting things into perspective. Janet Yellen, her colleagues, and a lot of financial people need to put down their Red Bulls, take a deep breath, and say Om next to a babbling brook. Get on with normalizing monetary policy and try a little quiet meditation.