Where To Look For Hope In Yellen’s Latest Speech

August 31, 2016

Where To Look For Hope In Yellen’s Latest Speech

  • The FED is predicting long-term average interest rates of around 3%, not the 7% that used to be the case.
  • Even small increases in interest rates will have a huge effect on yielding assets’ values.
  • Even Yellen it telling us that productivity is the main factor for growth, so add it to your portfolio.


There are two main drivers of what can be done to improve the economy. One is new inventions and structural reforms that increase productivity, while the other is monetary policy. As the former takes time to get results, we mostly talk about the latter. We can assume that increased knowledge and structural reforms take care of themselves. Companies are always investing in new technologies, and governments, no matter what kind, slowly push for social and political improvements. The results can only be seen if we look at it in the long term. The quality of our lives is much better now than it was 20 years ago and 20 years from now will be even better.

But one thing that seems to have an immediate impact on virtually everything is monetary policy, so everyone focuses on it. However, Warren Buffett says that the FED’s decisions don’t have an influence on him, he only looks for great businesses that are going to do well in the long term. In this article we are going to analyze the latest monetary policy developments without forgetting that other factors are more important in the long term, like productivity, technology, knowledge, etc.

Yellen’s Most Recent Speech

Chairwoman Janet Yellen held a pretty hawkish speech last Friday in Jackson Hole, WY. The first statement included the following words on the economy: “nearing the Federal Reserve’s statutory goals of maximum employment and price stability,” summarizing that while the economy isn’t growing very fast, jobs are looking very good and inflation is below the FED’s target as a result of cheap energy and imports. Looking ahead, she expects moderate economic growth, additional strengthening in the labor market, and inflation rising to 2 percent over the next few years.

This good news and a positive jobs report on Friday might move the FED to finally raise interest rates in its September meeting in three weeks. But the FED’s forecast about future interest rates is not so straight forward. The FOMC’s (Federal Open Market Committee) individual members’ forecasts are all over the place. Some forecasts see interest rates of above 4% while some still see current interest rates in 2018 with a 70% confidence interval. But the trend is clear and going upwards.

figure 1 rates
Figure 1: FOMC interest rate forecasts. Source: Federal Reserve.

In addition to the interest rate forecasts, something interesting for the long term is the new monetary policy toolkit that has been developed since the financial crisis.

New Monetary Policy Toolkit

Prior to the financial crisis, monetary policy was an easy thing compared to what it is today. Small, open market operations would have a significant effect on interest rates and rate declines were usually enough to increase liquidity. But today, in this global monetary easing environment, the FED is forced to develop new tools. The new tools include:

  • Paying interest on banks’ reserve balances in order to directly influence banks to charge higher interest rates if necessary, and vice versa.
  • The overnight reverse repurchase agreement that discourages participating institutions from lending at a rate substantially below what is offered by the Fed.
  • Large-scale asset purchases and increasingly explicit forward guidance as forward guidance increases the confidence in financial markets.

The new tools will probably stabilize the federal funds rate at 3%, which is well below the average of 7% that was seen between 1965 and 2000. Yellen explains the lower average interest rates as a consequence of slower global population growth, smaller productivity gains, and less spending.

What Does This Mean For Investors?

It’s simple, and it’s perhaps something you don’t want to hear, but higher rates mean a decline in yielding asset values as investors can get the same yields with less risk. It will inevitably push down the prices of bonds, utilities, gold and REITs. Even small changes in interest rates will have a big effect on asset values as interest rates are so low.

figure 2 interest rates and asset prices
Figure 2: Interest rates and yielding asset values. Source: Marginal Revolution.

As hawkish signs from the FED had already begun in June, the iShares U.S. Utilities ETF (IDU) has declined by 7.5% since its July high, and declined by 2.5% on Friday as Yellen spoke. A similar fate will affect REITs which we discussed in our article Investing In REITs Is Great, But Not Right Now. Gold, which has no yield, could also go down since a stable and good economic environment has historically not been good for the precious metal.  However, globally there is still a lot of monetary easing going on, so we might only see profit taking in gold, but be careful with it.


Yellen ended her speech with an urge to raise productivity by investing more in education, training, capital investing, research and reducing regulatory burdens. Higher productivity growth would increase interest rates by itself as productivity is the main factor for long term economic growth, and monetary policy can only aid a bit but can’t be the main driving force. This is also the logic one should follow with their own portfolio. Include assets that have productivity growth and that are in countries with productivity and demographic growth.

In the long term, things are pretty simple. In the short term, we know that higher rates will hit bonds and other yielding assets, but we don’t know exactly when it will happen as even the FED doesn’t know where rates will go in the next few years. As we always say, look at what you can risk in relation to your investment goals, and don’t risk too much if you are about to retire soon.