Economists Engaging in Guessing Games Again

Economists Engaging in Guessing Games Again

For those of you who have not been following recent news about the Federal Reserve Bank (the Fed), Janet Yellin, Chair of the Board of Governors, announced some time ago that the Fed is likely to raise interest rates at its upcoming September 16th meeting. Historically the Fed has always been vague about discussing the timing and magnitude of rate changes, on the grounds that such advance information could perturb the markets. Yellin has so significantly upended this philosophy that we now actually have dates on which we can base decisions. This remarkable shift has undoubtedly caused a number of Fed-watching and Fed-interpreting economists to have to find other jobs.

But I digress. The certainty around the date of the Fed’s first increase in the benchmark lending rate since 2006 became significantly muddier over the last couple of weeks as the U.S. stock market experienced its most volatile period since 2011. Bloomberg Business News reported last week that a number of economists have shifted their forecasts for the rate hike from September to October and some even to December. Currently 48% of 54 economists surveyed by Bloomberg News at the end of August still see a September rate hike, but that’s down from 77% based on a survey three weeks earlier. The same surveys found the number of economists predicting that the Fed will act in December jumped from 11% to 24%.

According to Bloomberg, “September supporters expect the U.S. economy has enough underlying momentum to shake off the recent global stock market correction spurred by a slowdown in China. The December backers argue there’s no rush to tighten because inflation rates are too low, and the Fed risks slowing it further by raising rates and spooking nervous markets.” They go on to assert that “Investors are still pricing in a 59 percent chance Fed Chair Janet Yellen and her board will raise rates at or before the December meeting.” The latter statement is certainly interesting in its specificity. How did Bloomberg (or whichever economist they chose to interview) come up with such a definitive number?

But this blog is not about media-bashing. It’s about predicting the future. I have no issue with economists spending their time and money attempting to handicap the Fed. My questions are more about what impact this will all have on the markets, and more importantly on our investment portfolios. Although we know a rate increase can be expected to result in a decline in both bond and stock prices, we don’t know the extent or the timing. And don’t bother looking to the economists for help. If only half of them are able to correctly predict what the Fed will do, why should we expect them to collectively be able to provide the right answer to the above questions?

Knowing this, what action should you take? You basically have four choices:

  1. Do nothing until September 17th. If the Fed raises rates, both bond and stock prices are likely to drop by some amount. In that case use whatever cash you have available to buy more bonds and stocks.
  2. Sell everything now with the intent of buying it all back on September 17th if the Fed does not raise rates on that date. Of course, if they don’t, there’s the possibility that the markets will react by driving prices higher before you have a chance to reinvest. Too bad.
  3. Flip a coin. If it’s heads, wait (choice 1). If it’s tails, sell (choice 2). That will give you almost the same likelihood of success (50%) as basing your decision on the economists’ forecasts.
  4. Ignore all these predictions and instead stick to your longer-term investment strategy.

Which approach will provide you with greater peace of mind?

One Response

  1. alan r says:

    The What if’s have ramped up glad th3ere are folks like you that can articulate the noise and help clients choose their path

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