Fed’s Yellen Trying Hawk Costume on for Size!
Is a Rate Shocker Looming?

Today was the big day. No, not the start of football season. That’s still a couple weeks away. I’m talking about the day Federal Reserve Chairman Janet Yellen released her big speech on the labor market in Jackson Hole, Wyoming.

If you’re not a millionaire, high-profile Wall Street economist, media bigwig, Ivory Tower academic, or caviar-and-champagne-swilling policymaker, chances are your invite got — ahem — “lost in the mail” like mine. But suffice it to say, this annual gathering is where global policymakers and central bankers meet amid the mountains and the pristine streams to talk shop.

This is where former Fed Chairman Ben Bernanke unleashed his QE2 experiment upon the world a couple years ago. It’s where the Fed had to face up to the destruction its reckless policies wrought on the housing market a few years before that. And now, it’s where Yellen had a great chance to confirm or refute current investor thinking about future Fed policy.

So what’s my take on her speech? I think she sounded relatively more hawkish … though not a ton more so.

She talked about a lot of the reasons why the weakness in wages and slowrebound in the labor market may be more demographically and structurally driven, rather than cyclical. Or in plain English, it has to do with the aging population, shifts in production overseas and other things the Fed can’t do anything about.

She also admitted the labor market has improved much more quickly than the Fed predicted this year, and implied that could continue. In such circumstances, she said the Fed would have to raise rates sooner than the market expects.

It’s worth pointing out that Yellen wasn’t the only Fed official sounding more hawkish this week. Philadelphia Fed President Charles Plosser got even more hawkishly riled up during his on-site CNBC interview this week. Then this morning, St. Louis Fed President James Bullard — a “middle of the road” guy — said on CNBC that investors were being too sanguine about the risk of rising rates and the strength of the economy.

You know my take: The Fed is way off-sides when it comes to policy, despite some lingering challenges like lackluster wage growth. The tone is shifting as the “Old Guard” policy falls by the wayside. And the risk of a rate shocker — earlier than expected hikes, greater-than-expected hikes, you name it — is increasing with each passing day.

In terms of market reaction today, we didn’t get much out of stocks. But shorter-term Eurodollar futures got hit modestly on the assumption these comments signal the Fed may move sooner than Wall Street expects. As a reminder, those futures fall in price when expectations for Fed hikes increase.

Meanwhile, the euro is really getting slammed (again). It just fell to a fresh 11-month low because these comments underscore the fact the U.S. is way ahead of Europe when it comes to potential tightening. That, in turn, is pushing the investments I’ve recommended to make money from a falling euro higher.

So what do you think will happen next? When it comes to stocks, you could read this news one of two ways. You could say the chance of losing the easy money prop sooner is negative for equities. Or you could say the fact the Fed is sanguine enough about the economy to consider raising rates earlier is positive. Share your take at the Money and Markets website here.

There is another course of action, too. Invest in sectors that don’t rely on the Fed for their well-being … and that shouldn’t get slammed even if the Fed does deliver an interest rate shock.

OUR READERS SPEAK

It’s a busy day on the website, with lots of comments on my latest piece about long-term “Car-gage” loans that look like home mortgages! So let’s dive right in.

Reader Dr. M. said: “I took a car note on a new car (in 2012) for 6 years at a near-zero interest rate. At that interest rate, there is no reason not to stretch it out. Its predecessor was 20 years old (same make and near same model), and one of the best vehicles I ever owned. If this new one turns out to be a keeper, I’ll easily keep it ten years or more — driving it for years after the note is paid off, maybe even handing it down to one of my kids.”

Reader MW added: “If you got the cash, take the zero interest and invest. If you do not, buy the best used car you can for cash or get it on a short-term car loan. I never buy new cars myself, they drop in value too much and are taxed too high!”

In addition, Reader Murl J. said: “I bought a 2002 Chevy Impala, new, with 60 months interest free GMAC financing. Still have it, so we have been driving a paid-for auto for 7 years. We have a very good credit rating and will look hard for another interest free auto loan for as long a term as possible when we buy again. Why not? As a retiree even low return on savings is still infinitely better than 0 interest.”

Good points! If a carmaker is handing out free money, and you’re financially responsible and can invest elsewhere, zero percent loans can work out.

The problem is that many buyers are not responsible enough. They finance too much of the car purchase price. They pay the bare minimum. The car depreciates in value faster than they pay the loan down.

Then they get suckered into buying a new car too soon. They have to roll the old car loan balance into the new car loan, and they sink even deeper into negative equity! That contributes to rising loan delinquencies, defaults, and repossessions. And that’s the real risk.

Still, Reader Ralph notes that the fallout likely won’t be as severe as it was with home mortgages. His comments: “People value their cars much more than their houses. If you lose your house after years of non-payment you can easily rent. Stop paying your car loan and it will likely be repossessed as soon as the creditor calls the repo company.

“On the creditor side, it’s much easier and timely to repossess a car than foreclose on a house. Many used car dealers outfit their cars with GPS locators and charge exorbitant rates, knowing owners will likely default. I don’t think the banks will take as much of a hit as the manufactures as car buyers ruin their credit, used car lots and auctions fill up with repossessed cars, and demand for new cars drops.”

Speaking of the impact on the economy, Reader Jean had some more extensive comments there: “Sub-prime auto loans are a direct result of Fed money printing since sub-prime rates more than cover current repo losses with zero cost of money. What lenders fail to see time after time is that easy financing is a bubble in progress, and they all burst in the end. Easy money cannot compensate for declining growth and declining income in the economy, it’s all based on unsound money.

“The major reason for declining income and declining growth in spending is an excess of increasing debt. The Fed has never allowed the economy to flush itself out and re-boot. Pouring cheap money on the problem is a temporary fix with the same bad results we saw in the housing bubble, and for the same reasons. When will they ever learn?”

Thanks for the comments, Jean. My sense is that the economy is in an OK place now, but that the real comeuppance will be down the road when rates rise and the easy money morphine drip ends. As I said earlier, I think that could happen sooner than many investors realize.

Have a great weekend everyone, and feel free to keep the discussion going at the website!

OTHER DEVELOPMENTS OF THE DAY

 Banks have been paying out fortunes in regulatory and legal settlements, thanks to their actions during the mortgage and housing bubble and bust. But could some bank stocks actually rally now that those penalties are in the past, especially if interest rates start to rise?

This article covers that possibility. My research shows you have to be selective — some financials can actually benefit from rising rates, while others will suffer!

 Merger activity spread to the utility sector today, with Dynegy (DYN, Weiss Ratings: C) agreeing to buy select coal and gas-fueled power plants for $6.25 billion. It’s purchasing those facilities from Duke Energy (DUK, Weiss Ratings: B) and Energy Capital Partners.

 Russia decided to press further in eastern Europe, sending at least 145 of its “relief” convoy trucks across the border into Ukraine today. Ukraine called the move an invasion that occurred without the sanction of the Red Cross. But so far it hasn’t triggered any additional hostilities.

 Speaking of geopolitical tensions, the front page of the Wall Street Journal website was filled with depressing headlines earlier today. They ranged from “Forty Killed in Attack on Sunni Mosque” to “Alleged Collaborators With Israel Killed in Gaza” to “Hostages Central to Islamic State Plan.”

Keep that in mind, as these kinds of tensions have implications for everything from market volatility to oil prices. They also underscore the ramping up of the War Cycles that my colleague Larry Edelson has discussed.

Reminder: You can let me know what you think by putting your comments here.

Until next time,

Mike Larson