We Don’t Always Have to Ride an Interest Rate Roller Coaster

In one of our recent notes, I reflected on my 30+ year career in trading and investing. Whenever I launch a new investment-focused firm, the markets get crushed soon after. Yikes!

With our particular investment strategies, we aren’t worried if we do see a market crash.

Looking back, though, it made me think about when I launched my career in money management in 1996.

One aspect that interested us was interest rates.

Here is the Fed Funds Target Rate back then…

You will see that it wasn't necessarily a period where rates were going higher back then.

For these five years, they basically were flat.

We think this might be instructive for what we could see in the environment going forward.

We have been used to a roller coaster regarding interest rates in the past few decades.

Here is the Fed Funds Target rate since 2000…

It looks like a rollercoaster!

For the last twenty years, the norm has been rapid moves up and down in interest rates.

Has this always been the case? Not at all!

Here is the chart from 1985 to 2000…

There was one period around the late 1980s where rates rode a big wave, but they were flat for the entire period in the late 1990s.

Our economy can exist in a state where the Fed is not responding aggressively to the economic cycle.

Some refer to this as a “Goldilocks” economy that is neither "too hot" nor "too cold.”

We don't know if the 1985 to 2000 period was always like that, but it was much less dramatic than the last twenty years.

We can argue why it was a less volatile period. Still, we don't think anything has fundamentally changed in the structure of our economy, which would mean it has to be more volatile.

Instead of the rollercoaster, what if we simply take the train around the amusement park?

When I started my career, this worked out pretty well for the stock market. Here is the chart of the S&P 500 for this same 1995 to 2000 period…

Wow! What a great chart!

This chart says a lot about the benefit of STABILITY in interest rates.

The problem for the economy is not necessarily higher interest rates but rather the speed at which they are going higher.

Businesses and consumers can deal with higher rates, especially at the levels we are discussing, with rates at 5%, not 25%.

The issue is that when these rates move fast, it becomes much more difficult for businesses to adjust. If they see rates go from 0% to 5% in a couple of years, then they can make those adjustments.

The recent move from 0.25% to 5.5% in the Fed Funds rate took just 15 months.

This type of rapid move can also potentially create real dislocations in the economy.

We saw a major one with what happened to the banking sector about a year ago. Banks dependent on customer deposits, paying essentially 0% interest rates, were caught flat-footed as customers started to chase higher rates elsewhere.

Of course, we can blame the bank management, and they deserve the blame.

The reality, though, is that there had not been as rapid a move in interest rates in almost two decades.

Where does this leave us today? How does it compare to the period when I started my career?

We remain concerned about the dislocations. Remember that when I started, we saw the collapse of the highly leveraged Long-Term Capital Management hedge fund. This failure alone almost took down the global financial markets.

For the moment, we have avoided a more significant crisis in the banking sector. We shall see…

If we avoid a significant financial crisis, reduced volatility in interest rates can lead to an attractive period for the economy and stocks.

These rates aren't so high as to hurt business, and some visibility on rate stability will allow businesses to plan and invest.

We aren't convinced that no crisis is looming on the horizon, but we know that we can exist in a world where we are not riding the interest rate roller coaster!