I recently attended the annual Rocky Mountain Economic Summit near Jackson Hole produced by the Global Interdependence Council.  Because the agenda is usually led by several Fed governors, as well as prominent economists from both the public and private sectors, this event seems to attract more participants every year.  And with all of the publicity and confusion around the Federal Reserve’s intention for interest rates this year and next, attendance this year was particularly heavy.  Although it would have been rewarding to gather some great new insight into these matters, none was offered.  It seems the Fed’s recent statements in the financial press are pretty representative of their predicament.


The quandary that the Fed is dealing with is that they would really like to begin a “normalization” process for interest rates, that is, begin raising short term rates in order to get those rates meaningfully above the current 0% rate.  This is certainly understandable for several reasons.  First of all, the Fed would like to have the ability to cut interest rates if/when the economy begins to weaken.  Obviously, at the current 0% Fed Funds rate, they do not have that ability (ignoring the controversial idea of negative interest rates).  Secondly, it is during periods of prolonged low interest rates that excessive lending can build and lead to over-leverage and credit bubbles.


However, the US economy really is not currently strong enough to bear the weight of materially higher interest rates.  Although 2nd quarter US GDP has not yet been released by the BEA, all expectations are for a number around 2.5% annualized growth.  Coupled with an inflation rate (CPI ex-food & energy) of 1.6%, real growth is most likely only around 1.0%.  Under normal circumstances, 1.0% Real GDP growth would call for stable to accommodative monetary policy (interest rates).  Especially in an environment of nearly nonexistent inflationary pressures.  Added to this tepid domestic growth environment, certainly the Fed is hearing a good deal of discouragement against raising interest rates from its European counterparts where growth is even worse.  Certainly the Fed is supposed to be independent of these opinions, but they are certainly not immune, especially given the global interdependence of these economies any more.


It is for these reasons that the Fed continues to state that its interest rate policy is “data dependent.”  They would really like to begin raising interest rates as soon as the economic data can bear such a policy. 


In this confusing environment, we are continuing to manage fixed income portfolios (bonds) for the eventual rise up in interest rates, which means short (2-3 year) maturities somewhat offset with slightly lower credit quality in order to generate some positive yield.  Equity portfolios (stocks) continue to be heavily weighted in companies that, despite the slow aggregate growth rates, are growing their revenues and earnings anyway.  That strategy seems to be paying off as these portfolios are outperforming their relative index YTD.  But we continue to be very vigilant about the timing of any rise in interest rates as this strategy will need to be adjusted accordingly.





Mark P. Culver

Managing Partner



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