Shame on Congress for its past debt battles; but shame on us if we get fooled again. Political brinksmanship resulting in the government shutdown may yet again undermine financial market confidence as the upcoming debt ceiling debate holds even greater significance, as I wrote recently in my October monthly “Fool Me Once,” and my colleague Russ has discussed as well. While the government shutdown makes a compromise harder to imagine, the much more negative consequences of failure to raise the debt ceiling make the need to reach a compromise on the debt ceiling greater.
In this anxiety-filled environment, what helps keep the economy on the recovery path?
Answer: “financial market conditions,” something the Fed has been concerned about lately. Indeed, the Fed surprised markets by maintaining its full bond-buying program rather than reducing it, as had been expected. Why?
Well, the rise in interest rates following the Fed’s May-June comments on “tapering” appears to be the reason for the Fed’s surprising decision to defer the reduction in its quantitative easing bond program.
The broader definition of “financial market conditions” refers not only to interest rates but also housing and stock markets and has been the main source of support for the recovery thus far. Specifically, that support has been in the form of a wealth-induced incentive for spending. The Fed knows this and is acting accordingly.
The chart below highlights this relationship. Savings rates reflect the mirror image of rising wealth: as consumers feel wealthier from rising stock, bond and housing values, they tend to spend more – and save less. That spending comes about not from rising incomes but as consumers are saving less.
But rising wealth generally influences higher spending through increasing the willingness to spend. Absent a return to the HELOC (home equity lending) frenzy of the pre-crisis days – an unlikely outcome anytime soon – rising wealth can support consumption only so far.
Ultimately, the strongest contributor to consumers’ spending is their ability to spend, and that comes from rising incomes. But those figures have yet to rebound higher following the crisis, as detailed in the chart below.
What does this mean for investors?
Answer: “Low for longer.” The Fed’s need to keep the recovery moving forward through its financial market conditions formula means that interest rates must remain low – for longer than many in the market had thought.