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Posted on 20 March 2015

"This strikes me as a case of investors making lemonade from lemons."

The communiqué that Federal Reserve Chairwoman Janet Yellen delivered from this week’s Federal Open Market Committee (FOMC) meeting brought with it the removal of the word “patient” from its characterisation of how it will approach changes to its interest rate policy. Perhaps never has so much focus been directed at the exclusion of a single word in a press release. Removing the word “patient” suggests the central bank will lift the federal funds rate sometime between June and September—depending on the data, of course. The response of capital markets (emphasis: markets) response was impressive if somewhat counter-intuitive: equity, fixed income, oil, and gold all pushed impressively higher.

How could the prospect of the end of the zero interest rate policy (“ZIRP”) in the world’s largest economy be viewed so uniformly positively by investors in markets that would ostensibly be hurt by the end of ZIRP? The answer lies in a comment the Fed Chairwoman made during her press conference on March 18 and delineated in the accompanying dataset of forecasts by the members of the FOMC. Figure 2 of the Fed presentation, titled “Overview of FOMC participant’s assessments of appropriate monetary policy,” reveals that the median forecast for the midpoint of the federal funds rate’s target range at the end of 2015 had fallen from 1.125% (when the reading was taken in December 2014) to the current 0.625%.[1] Simply put, members of the Fed now think that interest rates will rise at a slower pace.

This strikes me as a case of investors making lemonade from lemons. As ZIRP comes to an end, an inevitable change in the standards of capital allocation will occur. This is what typically happens when money has a price tag associated with it. But assessing the jump in US Treasury prices across the maturity spectrum left one scratching one’s head in wonderment. At the end of the day, the salient point remains that the central bank is laying the foundations for higher interest rates. Keep in mind it has been roughly nine years since the central bank lifted the target rate for the benchmark federal funds rate.[2] A new day is dawning.

[1] Fed Opens Door to June Rate Rise, Signals Slow Pace of Increases, March 18, 2015, Bloomberg and Federal Reserve.

[2] Federal Reserve Bank of New York.

Hans Olsen, CFA Global Head of Investment Strategy

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