We highlight a few key observations. First, policy accommodation following recent recessions has become more and more accommodative. The low point of accommodation in the mid ‘90s was around 0% in real terms, and in the early 2000s was around minus 50 basis points, or 0.5%. But the post-2008 period has seen the most persistently negative policy rates since those resulting from the inflation of the 1970s. What is less evident when looking at a chart of “real” policy rates is how extraordinary this period is for both its length (going on seven years) and for being at zero nominal rates. Both of these create a stronger “reach for yield” response from investors, suggesting a future market response to “normalization” that may be different than that observed historically.
From “Highly” to “Merely”
The Fed considers its monetary policy “highly” accommodative. Historically speaking, that is an understatement. Merely “accommodative” policy viewed from this historical perspective meant a zero real fed funds rate, “neutral” meant a 1-2% real rate, while “tight” policy meant a 2-4% real rate. “Highly” accommodative meant anything negative in real terms. Hence, moving from “highly” to “merely” accommodative implies a move in nominal fed funds rates from zero to 2%.
History is not kind when it comes to the Fed’s track record of exiting policy accommodation. And our concerns are heightened by a sense of complacency in bond markets that underprice such a move back to more “normal” fed funds rates. Our biggest concern is around areas of the fixed income markets most exposed to where the exit from ZIRP will have the biggest impact: shorter maturity yields.
Jeffrey Rosenberg, Managing Director, is BlackRock’s Chief Investment Strategist for Fixed Income, and a regular contributor to The Blog. You can find more of his posts here.