Markets are being whipsawed by paranoia over when US rates will rise and by how much. That’s sapping main street confidence in the US.
So we have a suggestion for the US Federal Reserve:
- Come clean, and tell the market where you expect interest rates to be in two to three years’ time.
- Tell the market that cash rates will likely be at one per cent by mid- 2017; and when you announce that, put up rates by just ten basis points (0.1 per cent).
That clear signal would help calm markets and allow long-term investors and businesses to plan and invest. And it would actually drive and sustain the US recovery.
What are economic trendlines in the US telling us?
In giving guidance on cash rate settings, the Fed is excessively focussed on short-term economic indicators, which is triggering market paranoia and volatility.
The likes of investment banks and hedge funds who seek volatility to generate income through short-term trading, are fuelling that paranoia.
Yet long-term economic indicators in the US continue to be positive, albeit at below long term trends. The US has shifted from recession to sustainable recovery; employment is growing; building starts are increasing; and the $US is rising.
But financial markets commentary continues to sap the real and the household sectors’ confidence.
The general population and the small business owner of the US must wonder about the sustainability of growth when interest rates are held at such low levels.
Further, retirees and pensioners who seek a yield are clearly not comforted by low returns on cash.
Zero short-term rates and negative real yields actually act against confidence and growth: surely that is clear from recent economic history!
What business and investors need
Instead of listening to traders and banks, who want volatility, the Fed should listen to businesses who want certainty about where rates are going.
It’s those businesses who will drive sustainable growth, investment and employment. That will instil confidence into the household sector.
Long-term investors also need guidance on the Fed’s interest-rate normalisation process. Yield curves in the US need to lift and the adjustment process needs to be clear and sensible.
So, as mentioned, we think the Fed should announce a small 0.1 per cent rate increase, and provide a clear guidance on where the cash rate would be in two to three years’ time.
Would rates going to one per cent in two years’ time rock the market?
We don’t think such a move would rock the market. Markets can adapt fairly quickly to that. It would not be “Armageddon”. Long-term investors would be ready to purchase.
It would signal to the market that interest rates are going up; but they’re going to go up at a slow and controlled rate.
The focus on short term interest rate moves would be irrelevant because the market will see the future more clearly.
What about Europe?
The above policy rate setting would have another clear benefit. It would allow Europe to catch up with the US economic cycle.
In two years’ time the ECB should have started its interest rate normalisation cycle.
By not charging ahead, and by outlining a plan, the US would allow an orderly return to positive real yields around the world – that’s what everyone wants and needs.