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As our community continues to recover in the wake of Irma, many who vacation here may be finding themselves in a quandary of sorts as to whether or not to return to paradise for the winter. Although it is imperative to our economy that we embrace the “snow birds” annual migration south, the events of this hurricane season may leave many in a quandary as to whether or not to venture back down to the tropics or to simply take a winter off while the recovery continues. Those of us lucky enough to live here know that there should be no question for our friends from the north. Paradise waits.

 

A recent Associated Press article brought to light a new quandary facing The Federal Reserve and their position on maintaining balance within the economy and the financial markets. As this raging, albeit perhaps a bit artificial, bull market continues to grow to the sky, many have turned their attention to the actions of The Fed, or in this case, previous actions by The Fed. As many may recall, in order to prop up the financial markets on the heels of the last crash of 2009, The Fed resorted to a practice referred to as “artificial stimulation” whereby The Fed would print US Treasuries and then buy them back. As “Ponzi scheme” as this sounds, it accomplished the goal of stabilizing the economy while recovering from the Great Recession; at least for now.

More: Money Talks: Life, markets and cycles

Fast forward to today where the day of reckoning has finally arrived. The flip side to the artificial stimulus is the very real fact that at some point The Fed must rid itself of the massive debt load acquired while repurchasing our own treasuries. The formula achieved the goal of stabilization, however as the AP story illustrated, as we sit on an approximately “$4.5 trillion balance sheet” many of these treasuries “will mature without being replaced.” In real numbers, “reductions of $10 billion per month will begin and gradually rising over the next year to $50 billion a month.”

Retiring the acquired debt can have a negative impact on the state of both the economy as well as the financial markets. By now many are familiar with the concept of rising rates exerting downward pressure on the economy and the stock markets. Rising rates create increased costs of conducting business. Manipulating interest rates has traditionally been the greatest hurdle for The Fed as they attempt to orchestrate the ever so coveted “soft landing” for any major shifts in monetary policy. Now we are forced to exercise a little known act for The Fed to pull off without upsetting the apple cart.

According to the AP article, the risks are pretty clear in the wake of this massive Treasury selloff. “The risk exists that investors could become spooked by the rising number of bonds being transferred back into private hands.” The concern is that this phenomenon could create an environment where “long term rates might surge undesirably high, which could weigh on the economy.” So, now The Fed is battling essentially on two fronts; rising rates which are inevitable and exiting tremendous amounts of treasury debt back into the financial markets. The recent shift away from bonds and into the stock market carries even more potential volatility as the increased liquidity flowing into stocks would backfire if and when the inevitable correction occurs.

The Fed has done an adequate job of informing investors that the only direction rates can go from here is up. In fact, they have actually revealed a timeline by which the increases will occur. The predictability is created in an effort to soften the blow by allowing transparency for investors. There will be a tipping point as rates steadily increase. In fact, many believe that the unprecedented run up in values with the stock market have camouflaged the fears of rising rates. The continued march to glory for stocks will, at some point, leave investors with a truly diversified portfolio of alternative assets to enjoy the life of a SWAN, Sleep Well At Night.

William F. Hague is a managing partner of Hague Wealth Management; 239-389-1999 or WFHague@earthlink.net. The opinions and observations stated above are those of the columnist.

 

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