1. Home
  2. Our Firm
  3. News
  4. Financial Times: Chances of Regret High as U.S. Policymakers Face Familiar Dilemma

Our Firm

September 15, 2015

Financial Times: Chances of Regret High as U.S. Policymakers Face Familiar Dilemma

Chairman of Investments and Global CIO Scott Minerd explains in a Financial Times editorial why, regardless of the path the U.S. Federal Reserve chooses to go on interest rates, the likelihood of regret is high.

 

Twice in the past 30 years the U.S. Federal Reserve has faced the prospect of prematurely abandoning tightening during market turmoil. Today, global currency devaluations, market volatility, and plunging commodity prices have trapped the Fed in a similar policy dilemma.

In 1987, the central bank aborted rate rises and reversed course after a stock market crash. Again, in 1998, after the failure of Long-Term Capital Management (LTCM), a highly leveraged hedge fund, the Fed abandoned its planned rate increases to stabilize markets and avoid a global crisis. In both cases, the unintended result of delaying was inflated asset prices, which ultimately destabilized the economy, and led to severe financial consequences and recession.

In 1986, inflation slowed as oil prices collapsed, raising serious concerns about U.S. economic expansion following the worst postwar recession up to that time. Policymakers were slow to raise rates, allowing for a surge in equity prices in early 1987 as energy prices rebounded.

After falling behind the curve, aggressive Fed actions to address inflation inadvertently pricked the stock market’s speculative bubble. In October 1987, U.S. equities plummeted more than 30 percent. The Fed quickly reversed course and reduced rates.

By mid-1988, markets stabilized and the Fed again raised rates to head off inflation. By this time, more than four years of accommodative monetary policy had led to a commercial real estate boom with a glut of new properties. As the economy tumbled toward recession in 1990, a sharp decline in property values caused defaults and the failure of financial institutions. The government-sponsored Resolution Trust Corporation was set up in response to resolve troubled banking assets.

After the ensuing recession and another period of accommodation, the Fed again raised rates in the mid-1990s. During this time, many Asian nations had pegged their currencies to the U.S. dollar. By 1997, the pressure to maintain these pegs amid rising U.S. rates became too much for some. Thailand was first to break its peg, allowing the baht to collapse and increasing pressure on neighboring economies in a dramatic round of competitive devaluation.

By 1998, contagion from emerging markets reached the United States, pressuring domestic markets. A collection of 14 major financial institutions convened by the Fed intervened to stem the collapse of the LTCM hedge fund that threatened the solvency of the global financial system.

Once again, the Fed aborted plans to raise rates, allowing equity prices to skyrocket. When the Fed finally tightened, stocks began a long, deep slide. Numerous companies that flourished amid the speculative wave failed.

Today, policymakers are caught in this familiar dilemma. Labor markets are moving toward full employment, and declining energy prices and a stronger dollar have resulted in languishing inflation. Still, questions remain about the viability of sustained economic expansion in the United States and around the world, and volatility is rising.

At the same time, currency devaluation, particularly in Japan and the euro zone, is putting pressure on countries to devalue to improve export competitiveness. Those countries slow to devalue, like China, are feeling economic pressure at home, driving down asset prices and increasing deflationary pressures, escalating the risk of financial contagion abroad.

The Fed is hard pressed to justify a rate increase based on its self-prescribed metrics, which include rising inflation and an improved employment situation with clearly rising wages. At best, policymakers can argue that the prospects for wage growth and inflation are improving, but clear evidence is lacking.

A preemptive rate increase seems risky and opens the Fed to potential criticism given the fragility in financial markets and the prospect that rising U.S. rates could exacerbate foreign economic turbulence. But while prices and wages remain tame, the risk of another asset bubble is increasing. If policy remains highly accommodative, the likelihood grows that asset classes including commercial real estate, equities, or certain categories of bonds could become dangerously overvalued.

Regardless of the path the Fed chooses, after seven years of accommodation and now facing volatile global markets, the likelihood of regret is high.

Scott Minerd is Global Chief Investment Officer and Chairman of Investments at Guggenheim Partners. Read more in Scott's Perspectives

 
Important Notices and Disclosures

This article is distributed for informational purposes only and should not be considered as investing advice or a recommendation of any particular security, strategy or investment product. This article contains opinions of the author but not necessarily those of Guggenheim Partners or its subsidiaries. The author's opinions are subject to change without notice. Forward looking statements, estimates, and certain information contained herein are based upon proprietary and non-proprietary research and other sources. Information contained herein has been obtained from sources believed to be reliable, but are not assured as to accuracy. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Guggenheim Partners, LLC. ©2015, Guggenheim Partners.

Past performance is not indicative of future results. There is neither representation nor warranty as to the current accuracy of, nor liability for, decisions based on such information.



November 15, 2018

Glen Santangelo to Join Guggenheim Securities as Healthcare Analyst

Guggenheim Securities, the investment banking and capital markets division of Guggenheim Partners, announced today that Glen Santangelo will join the firm in January as a Managing Director in a planned expansion of the firm’s Healthcare Research team. Mr. Santangelo will focus on the coverage of Healthcare IT and Distribution companies in close collaboration with the growing therapeutics and services team.

Read More

October 15, 2018

Guggenheim Partners Selects Second Cohort of Network for Social Innovation

NEW YORK - Guggenheim Partners is proud to announce the selection of four non-profit organizations for the second cohort of the Network for Social Innovation. The Network for Social Innovation is a Corporate Social Responsibility venture strategy that identifies promising, early-stage organizations using innovative solutions to solve enduring social problems. It recently won WealthManagement.com’s “Corporate Social Responsibility/Diversity” Award for an Asset Manager.

Read More

October 15, 2018

Guggenheim Fourth Quarter 2018 High-Yield and Bank Loan Outlook: Strong Earnings Growth Is Masking the Rise in Borrowing Costs

NEW YORK, NY – Guggenheim Investments, the global asset management and investment advisory business of Guggenheim Partners, today provided its Fourth Quarter 2018 High-Yield and Bank Loan Outlook.
 

Read More



© 2018 Guggenheim Partners, LLC. All rights reserved. Guggenheim, Guggenheim Partners and Innovative Solutions. Enduring Values. are registered trademarks of Guggenheim Capital, LLC.