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SKARBECK: Long-term investors look beyond Fed news

March 21, 2015

Ken SkarbeckDuring the eight Federal Open Market Committee meetings each year, the Fed attempts to communicate, often vaguely, the institution’s thinking behind its policies to market participants. In most cases, the Fed doesn’t want markets to be surprised by a sudden change in monetary policy.

The word “patient” took center stage last week as investors waited for the conclusion of the March 18 meeting. In January, the Fed pledged to be “patient” in deciding when it would raise rates, which pundits expect to happen as early as June.

The cognoscenti who dissect every word in FOMC statements predicted “patient” would be dropped from the current “Fedspeak” press release. They were correct—and Voila!, the Dow Jones tacked on 300 points.

Just about every market swami has weighed in with advice for Janet Yellen as she considers whether to raise interest rates for the first time in nine years, and six years into a zero-interest-rate policy.

The financial press was in a tizzy last week as the self-important founder of Bridgewater Associates, Ray Dalio, fired a warning salvo to Yellen that raising interest rates would repeat 1937. We are told to pay attention to Dalio because he runs one of the largest hedge funds. His long-term record is admirable, yet his investment performance in recent years has slipped.

Instead of attempting to influence interest-rate policy, Dalio ought to be more concerned with his risk-parity strategy and how his leveraged bond portfolio will perform when rates rise.

In addition, the Bank of International Settlements recently stated it was concerned that bond market liquidity hinged on a few big players, so you aren’t doing anything irrational, are you, Ray?

Conditions in 1937 were different. Notably, unemployment was sky high at 14 percent. Then the Fed tightened monetary policy by doubling bank reserve requirements in order to restrict lending and President Roosevelt tightened fiscal policy, and a recession followed.

Today, with deflationary pressures creating a bizarro world for interest rates and currency valuations, investors have their work cut out. Many countries are in a race to weaken their currencies to spur export growth. The euro has lost 17 percent of its value since fall—a huge move for a major currency. Conversely, the U.S. dollar has been strong, and raising interest rates could add to its strength.

Interest rates are supposed to reflect credit-worthiness of a country, thus investors should require financially weak countries to pay higher interest rates to compensate for risk. That makes it difficult to explain why a 10-year government bond in the United States yields 2.05 percent, while 10-year bonds in France, Italy and Spain yield 0.53 percent, 1.25 percent and 1.23 percent, respectively. And some bond rates are negative in Germany, Switzerland and Sweden.

The tea leaves in this FOMC statement still point to a June or September rate increase. The market will digest this change in Fed policy. Long-term investors will look past any short-term market disruptions and recognize they often create investment opportunities.•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money management firm. His column appears every other week. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.

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