Rarely has there been such unanimity of opinion among both Federal Reserve officials and the cadre of analysts who track and try to predict their future moves.
Monetary policy will be tightened with a series of increases in the central bank’s federal-funds rate target, plus an end of its large-scale securities purchases and then a reduction in its massive holdings of Treasury and mortgage-backed securities, they say. The only disagreement among Fed watchers is how hard and fast the central bank will move to reverse its ultra-easy policy.
Indeed, there’s been a kind of competition in forecasting the number of boosts this year in the federal-funds target, which still sits in a rock-bottom 0%-0.25% range, and the size of the liftoff widely expected at the March 15-16 Federal Open Market Committee meeting.
In the past week, J.P. Morgan joined Bank of America and Goldman Sachs in predicting seven 25-basis-point increases, which would raise the target range to 1.75%-2% by December. (A basis point is 1/100th of a percentage point.) A growing minority of observers are predicting a rare 50-basis-point initial increase, to signal the Fed’s resolve to counter inflation, which is running at a four-decade high.
Indeed, Credit Suisse investment strategist Zoltan Poszar, who has a wide following among money-market cognoscenti, says a 50-basis-point hike should be accompanied by a $50 billion sale of Fed assets. That, Poszar writes in a client note, would drain liquidity, deliberately provoking tighter financial conditions in a manner reminiscent of former Fed Chairman Paul Volcker, who broke the back of inflation in the early 1980s. Poszar postulates that this not only would slow inflation, especially in rents, but also would increase employment.
Harking back to his experience growing up in post-Communist Hungary, when generous transfer payments and early-retirement benefits sapped labor-force participation, he suggests that “the path to slower services inflation…is through lower asset prices.” A correction in stocks and other risk assets would lead some beneficiaries of their inflated prices to go back to work. The “young feeling Bitcoin-rich” and “the old feeling mass affluent” who are retiring early would return to the labor force, he provocatively argues. And, he contends, a correction won’t kill economic growth because wage gains of 5% can easily offset higher mortgage payments.
“The decisions of central bankers are always redistributive. For decades, the redistribution went from labor to capital. Maybe it’s time to go the other way next. What to curb? Wage growth? Or stock prices? What would Paul Volcker do?” Poszar rhetorically asks.
Wall Street veteran Robert Kessler also sees the Fed’s actions leading to a stock-market downturn. But rather than freshening your résumé, he recommends protecting past capital gains with a stake in the most unloved asset of all: long-term U.S. Treasury bonds.
Until last year, Kessler was the longtime head of his eponymously named investment firm, which served global institutions and ultrawealthy individuals. Now retired, he splits his time between his homes in Denver—overseeing his art collection, part of which is on exhibition at local museums—and Costa Rica, along with the ultrarich who dock their multi-hundred-million-dollar yachts to escape the woes of the world. He also manages his personal investments.
The very unanimity of opinion that bond yields will continue to rise makes Kessler go against the consensus—a familiar tack for him. Over the decades in which he managed portfolios of Treasuries, they rarely had fans on Wall Street. He suspects that the disdain reflects the fact that big brokers don’t make much peddling U.S. government notes and bonds, compared with what they earn selling corporate debt and equities or exotica, such as derivatives.
Every market cycle of the past four decades has ended with a break in interest rates and a surge in bond prices, he points out, with each successive peak in yields lower than the previous one. For example, the benchmark 10-year Treasury yield was 6.5% ahead of the dot-com bubble’s bursting in 2000. It had fallen to around 5.25% by the time the housing bubble started to burst in 2007. And it was in the low 3% range in 2018, before the stock market had a near-bear experience.
What’s different this time, Kessler continues, is the enormous layering of debt on the financial system. The massive borrowing by Washington to fight the effects of the pandemic pushed total marketable federal IOUs to $30 trillion. Relatively small increases in the cost of servicing that debt will put a brake on the economy, reversing interest rates to the downside, he maintains. He sees a similar situation as is apparent in Japan, with a highly indebted economy leading to persistently low interest rates and inflation, and a stock market still about 30% below its late 1989 peak.
At the same time, this year marks the end of various fiscal supports provided by the pandemic relief, Kessler notes. The much-cited buildup of excess savings is concentrated among the 1%, while the rest of America will face lower real incomes and higher prices. This is the scenario predicted here by former Barron’s Roundtable stalwart Felix Zulauf last December, who warned that the S&P 500 could plunge 38% in this year’s first half, to 3000.
After Thursday’s 2.1% plunge, the large-cap benchmark was down 8.7% from its peak just after the turn of the year. Kessler says that typical investors with a stock-heavy 401(k) retirement plan ought to be sitting on big gains from the near-100% recovery in the S&P 500 from its March 2020 lows. They should protect those profits, he adds, by putting a sizable portion in 30-year Treasury bonds—not for their interest income of 2.30%, but for the prospect of capital gains of 20% to 30%. That is similar to the advice proffered a couple of weeks ago by Kessler’s fellow long-term bond bull, economist A. Gary Shilling.
With inflation running above 7% and the Fed set to lift rates, a 10-year Treasury yielding under 2% might not seem alluring, especially given the prospect of further price declines if yields move up. Shorter-term Treasuries, such as the two-year note at around 1.50%, already price in much of the rate hikes anticipated by Fed watchers. In any case, safe, liquid assets can protect past gains or provide liquidity for future buying opportunities.
Sometimes fortune favors the prudent, not the brave.
Write to Randall W. Forsyth at [email protected]