This is the end. The end of accommodation. The end of easy money.
The Federal Reserve hiked interest rates last month for the 8th time, bringing the Effective Fed Funds Rate up to 2.18%, its highest level since April 2008.
More importantly, the Fed Funds Rate now stands above U.S. core inflation (2.17%) for the first time in 124 months.
This brings to an end the longest period of easy money in history.
Saying there’s no comparison to the current period would be a gross understatement. Historically, the Fed has initiated easy money policy only as an emergency stimulus, either during or shortly after a recession. When clear signs of expansion took hold – and an emergency measure was no longer necessary – the Fed would begin to normalize rates.
In the current cycle, this simply did not happen. The recession ended in June 2009 but the Fed held off from hiking rates until December 2015. Until last month, they were acting as if emergency measures were still necessary.
The prior record of easy money lasted just 39 months, from October 2001 to December 2004. Many believe this was one of the principle causes of the housing bubble that peaked in 2006. The easy money period that just ended exceeded that record by over 7 years.
The questions for investors today:
(1) What excesses have been built from this extraordinary period of easy money?
(2) Will market behavior begin to change now that it is over?
As to the first question, a strong argument can be made that easy money has found a home: U.S. equity valuations are at the highest end of their historical range, housing is stretched once again in relation to incomes, and the premium from owning high yield bonds is at its lowest level since 2007.
As to the second question, no one really knows because we’ve never been in this situation: over 9 years into an expansion with the Fed just now moving to a neutral policy. This is the end. But what comes next is far from clear. There’s simply no precedent.
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