The Coming Interest Rate Hike

We thought it was time to revisit the topic of the coming interest rate hike.  Certainly it is likely there is a rate hike coming, but when it will happen no one knows for sure.

Earlier this week we watched Chair Yellen testify to congress and at first it seemed that she wanted to raise rates in March, but in the end she didn’t give me, or any markets, confidence that she really meant it.  Of course they are data dependent, but if they don’t raise when they have the chance with good economic data when will it happen?  This the same sad story we have witnessed for multiple years already.  We saw inflation tick higher in January by a “hot” .6%–much of the rise driven by food and energy, but as Yellen acknowleged in her testimony food and energy are large parts of the average consumers budget.  Employment is reasonable, both from a job creation point of view as well as unemployment rate, although wages remain somewhat stagnant, but let’s face it if we are to wait for each and every data point to be perfect then we just as well concede that near ZIRP (zero interest rate policy) is here to stay.  Let’s get the Fed Fund rate up in March by another 1/4%!!!

Yellen also testified this week that she would begin to let the balance sheet “run off” when interest rates are normalized (not certain she defined “normalize”).  The Fed holds over $4 trillion in assets on their balance sheet as a result of “QE” (quantative easing)–prior to 2008 when the 1st QE program began the normalized balance sheet had assets of $800 billion–only 20% of what it is today.  Every month $40 billion in debt that the FED holds matures and instead of simply letting the balance sheet fall naturally they turn around and reinvest the proceeds–a perpetual QE program.  Month after month after month more opportunity to lower the balance sheet has passed by. If the Fed intends to wait until interest rates are normalized before beginning to reduce the balance sheet we simply should admit that it isn’t going to happen—–EVER.

So we simply hope that the FED will raise rates in March–it is the least that can be done.

Here is the problem.  The markets have almost written off the odds of a March hike.  The current odds of a March hike is pegged at 17%.  Wow!!  This means either A) there will be no rate hike or B) there is going to be a lot of blood spilt in the next couple of weeks.

The bottom line is this–it doesn’t matter for us whether the Fed raises rates or not–we are positioned for a rate increase to the extent that we reasonably can be–meaning quite a few shorter duration securities.   If there is a major hit because of a surprise rate hike we will simply have to deal with it when/if it happens.  Keeping dry powder at the ready is always best in times of uncertainty (at least for us).  For those with a potful of perpetual preferreds you might want to say an extra “Hail Mary” at bedtime tonight–or at a minimum simply understand that a 2-10% hit is coming your way.