Janet Yellen will spin her Fedspeak on Aug. 26 at the annual Jackson Hole conference. Investors worldwide will scour the text for hints at what the future holds. In the past, Federal Open Market Committee (FOMC, a.k.a. Federal Open Mouth Committee) bosses have used the speech to alert the market to a change in policy. The most memorable was Ben Bernanke announcing QE2 (Quantitative Easing 2) on Aug. 27, 2010. There is no expectation of a QE5 – or whatever number we are at now as I've lost count – speech this time around; in fact, quite the opposite. When will the Fed raise rates again?
Conventional wisdom suggests Ms. Yellen will be cautious as it has been her modus operandi since she took over from Mr. Bernanke in January, 2014. She will probably attempt to play the Goldilocks card – not too hot, not too cold, we'll decide when to move rates when it's just right, whatever that means. But maybe, just maybe, she will tilt the deck toward the possibility of a September hike.
Conventional wisdom also suggests they do not want to interfere with the U.S. election so they would look to wait until after the vote to move rates. They actually have moved rates in both directions in front of an election. In 2008, they cut rates twice in October in the wake of the post-Lehman volatility. They also tightened rates a few times in the months before the 2004 election.
So those who say they don't want to get in the way of the political process are void of facts. Wages are rising and the markets are strong right now – they have the cover they need. Inflation is lower than desired, but they will never likely get the perfect Goldilocks opportunity.
I have suggested for several years that interest rates may need to stay near zero for decades to help the world grow out of this debt-fuelled, demographically challenged conundrum. I have written in recent weeks about the challenges to monetary and fiscal policies against the headwind of debt and demographics as to why I'm defensive in my client portfolios. This question of interest-rate "normalization" will probably be an ongoing narrative in markets for the foreseeable future.
Historically, when you want to reduce the volatility risk in your portfolio, you would increase the amount of fixed income (or cash) relative to the more volatile equities. You would also shift portfolios to less volatile holdings such as utilities, consumer staples and high-dividend payers like real estate investment trusts (REITs). With bond yields so low and interest-rate sensitivity so high, they do not offer the same protection they have historically. This week, former FOMC boss Alan Greenspan opined that the committee would be raising rates soon and perhaps far more than the market was ready for. A gaggle of other FOMC members have also warned of a pending rate hike.
The FOMC (Bernanke) first mentioned starting to normalize rates in May of 2013 and it was followed by the "taper tantrum." The market was not ready for a rate hike and everything interest-sensitive sold off hard for a few months. The most at risk are the overvalued utilities (ZUT, XUT) and REITs (ZRE, XRE, VRE, RIT), which took the brunt of the selling pressure. The yield on five-year Canada bonds went from 1.15 per cent to 2.15 per cent, which saw short-term bond funds (like ZCS, XCB) fall about 2 per cent, wiping out a year's worth of yield.
Of course, they never actually increased rates for 2.5 years (December, 2015) after first warning the market. So all these exchange-traded funds (ETFs) bounced back in 2013 and 2014 if you held on. The moral of the story is that even the FOMC, which decides the path of interest rates, does not know exactly when they will raise rates, making it a bit of a mug's game to anticipate with much certainty.
It has been 40 months since that point and they have managed to raise rates once. Since raising rates (December, 2015), the U.S. economy has grown at about 1 per cent, so it is easy to make the argument why they will do nothing in September too. The lower-for-longer rate conundrum is not likely going away any time soon and some have suggested they want to raise rates only so they can cut them again in the next recession.
So what is the best value right now defensively for Canadians? I love the idea of sitting in a U.S. money market ETF like SHV.N or PSU-U.T with the Canadian dollar at 78 cents. The most likely scenario for the next few months is that the combination of a pending U.S. rate hike and the likelihood of crude oil falling back to $35 as inventories build after the summer driving season pushes the Canadian dollar 4 to 5 per cent lower toward 73 cents some time in Q4. That's a nice return for sitting in cash!
Larry Berman is co-founder of ETF Capital Management. He is a Chartered Market Technician, a Chartered Financial Analyst charterholder and is a U.S.-registered Commodity Trading Advisor.