What Investors Are Getting Wrong About The Most Important Number In The Global Economy

Steven Blitz, chief US economist at research firm TS Lombard, joined us to discuss the future path Federal Reserve (Fed) interest rates – and what they mean for your investments. 

As far as Steven is concerned, the COVID-19 vaccination program is unadulterated good news for the economy – and things will steadily get back to normal from here. That means that, as the economy normalises, the Fed will be forced to normalize interest rates too. Which means bringing them back up from the current extremely low levels – and that is likely to start happening in about two years time, not the four years currently expected by markets. 

Here’s a transcript of the interview. Hit 🎧 in the app to listen.

Andrew Rummer: Before we get too into things, Steven, why should investors care about US interest rates at all?

Steven Blitz: Well investors should care because the whole world is priced off of US yields. And determinations of risk and return – whatever model people are using, whether it's anecdotal or highly quantitative – starts with US interest rates beit at the very short end, or the 10-year yield, or some combination.

Andrew: You're predicting that the Fed will increase interest rates around the final quarter of 2022. How have you come to that conclusion?

Steven: We became – I became and, as a firm, we became – much more upbeat once the vaccine became reality – as opposed to, "we're working on it". You know, there's a lot of vaccines that science has been working on for a long time, and it's yet to come. But this one's arriving. And so I'm not trying to minimize in any way the disruption to growth and people's lives that's going to occur between now and when we start getting vaccinated. But, you know, as an analyst, as an investor, you have to look past that to see what's going to happen. And one of the interesting points about this whole episode has been that whenever you see any kinds of surveys of people – or business for that matter – their forward confidence in the economy never wavered. And it normally waivers during a recession, and wavered in the 2008/9 recession. It wavered in 2016, when the economy was slowing down. You never saw that standard recessionary response. So my feeling is that once you have the vaccines, once people feel, "OK, we're past this now," you are going to unleash a tremendous surge in activity that's going to, in and of itself, carry the economy forward – and push the economy back up towards where it was on a dynamic basis. 

This coming disruption is not going to be fun for anybody, but it'll pass and the economy will start to really surge. And I think people are tired of staying home and working from home. And I think you're going to see a lot of momentum return. And it's going to build on itself and the economy is going to get back to where it was – it's going to take, you know, six quarters. But once you're there, holding the short end to a negative yield – an increasingly negative yield – is not the handshake that the Fed has given the market, so they'll find a way to communicate that. 

And so they're not going to go into like every quarter, we're gonna raise rates every six weeks. They may say, “we're gonna do this, and then we'll see where we are in six months.” Maybe they'll do two hikes a year. So I think it's clearly going to be a much more measured response than we're used to – but they're not going to sit with the nominal economy, the real economy, basically where it was in 2019 and 4-4.5% unemployment rate. There's no reason for them to continue to let the short end of the curve in real dollar terms – in real yield terms – become increasingly negative.

Andrew: Why is it a problem if real-terms interest rates – ie. interest rates minus inflation – are negative? Why is it something the Fed might worry about? 

Steven: Well, because then it's the same thing as why the Fed wants a little inflation, but not too much inflation. Because now money gets invested in places and in directions that aren't necessarily because they make sense to the economy and production – all that kind of good stuff – but they're doing it because money is free, they’re giving you money to borrow. Right now, at the moment, what we've been seeing is that money has been going into the equity market. And it's pushed the equity market – more so tech than other sectors – but it's pushed the overall equity market to very high levels of valuation.

Andrew: Is there anything you could imagine happening in the next few months that would radically change your prediction about the Fed increasing interest rates in late 2022?

Steve: Well, obviously, the biggest thing that would change my thoughts are if the vaccines turn out to be a mirage. That's number one. I don't think that's going to happen, but you know, maybe it's 1% – but, you know, it’s not zero, right? The other thing is that this term, if this term ends up being worse, and we don't get any government transfers, and that creates a deeper hole for the economy to climb out of – that would change things.