From “Low for Long” to “Low for Forever”

When I got to OppenheimerFunds in the spring of 2009, I had one consistent message for all of our stakeholders: Rates are going to remain low for the rest of my career and I plan on having a long career. That statement had turned out to be truer than what I had anticipated at that moment.

Based on the recent Fed policy discussions and the post-FOMC Powell press conference, I am tempted to change that assertion to “Low for Ever”.

The Powell Fed has finally thrown in the towel after a long struggle with the Phillips curve. The Corona Virus got us here in a hurry but the ever lower rates was an inevitable path for the US economy for quite a while. Even before the virus, there had been no need to ever raise rates. But the Fed following its orthodox methods did try raising rates a few times but quickly walked it all back. I firmly believed, again even before the virus, that we would have gotten to current level of low rates; the virus just brought it forward by a few years.

This is a really crucial point that gets lost in the heat of the moment. Covid19 wasn’t a game changer for US growth or rates in the long run: we were on course to get here in a few years irrespective. US growth and inflation was never going to be close to Fed expectations and the Philips curve had been dead for a while despite the Fed’s pretensions otherwise. Monetary policy had to remain easy because the developed market economies face too many head winds. That was true before the virus, and it surely I truer today in light of the virus.

 While the Fed has to be commended for its overwhelming monetary and liquidity response after the Corona crisis, it still is reluctant to get ahead of the curve. The September 2020 FOMC meeting provides evidence to that effect.

On the positive side, under its new policy doctrine, the Fed provided new forward guidance that delays any potential rate rise until maximum employment and inflation is expected to rise above 2% and is on track to exceed that for some time. At the surface, this may seem routine Fed blah blah blah, the “exceed that for some time is new and very important. This is especially true in light of a case to me made for core inflation to get close to 2% -- temporarily – as soon as end of 2020. When and if we get there, this guidance would matter a great deal.

Further, to drive the point further, most FOMC members do not expect any rate increase until 2023.

Good and expected moves.                         

But the FOMC, at that same time, showed its orthodoxy as well. They left the asset purchase plan unchanged. This is an unfortunate outcome. The economic rebound is already slowing, fiscal stimulus is MIA, markets were expecting a change in the asset purchase plan – under the circumstance some modest modifications of the plan on the maturity front would have helped. The FOMC, by not doing anything on this front, provides the long-end TSY vigilantes an unnecessary opening. In other words, the Fed could have gotten ahead of the curve, but decided not to. Too bad.

But these are minor quibbles.

Given the current state of play, I continue to believe that both nominal and real rates are going to remain LOW FOREVER. There is not a lot anyone can do about that and as investors we have to figure out a way to deal with that.

From a longer term perspective – in a post Corona world, and yes there is a post Corona world to plan for -- the biggest beneficiary of the new official Fed interest rate doctrine has to be the EM economies. The new policy effectively reduces the potential for episodic violent capital outflows out of the EM primarily driven by FED policy machinations which have been a bane for these growing but fragile economies.  As a result EM policy makers certainly will have a lot more operating flexibility than they had before which should be helpful to capital flows, growth prospects and asset prices.