Fed Birth Pared Returns as New Century Looms: Cutting Research

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A woman walks past the Marriner S. Eccles Federal Reserve building in Washington, D.C. Close

A woman walks past the Marriner S. Eccles Federal Reserve building in Washington, D.C.

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Photographer: Andrew Harrer/Bloomberg

A woman walks past the Marriner S. Eccles Federal Reserve building in Washington, D.C.

The creation of the Federal Reserve 100 years ago helped develop a new world of investing in which bond returns fell, and the start of its next century may also mark a new era in monetary policy making, says Deutsche Bank AG.

Returns on 10-year Treasury notes adjusted for inflation were about an annualized 4.5 percent in the 100 years before the Fed and less than 2 percent in the 100 years after the Fed was born on Dec. 23, 1913, according to the study, released Sept. 12 by strategists including London-based Jim Reid. The return on equities as measured by the Standard & Poor’s 500 Index (SPX) was largely the same over the two periods, at about 7 percent.

The Fed has had a “fairly large” influence on prices: The consumer price index ran 3 percent higher per year under the central bank than it was in the 100 years before, the authors said. That means while annual growth has been higher than in the previous century on a nominal basis, it’s almost 2 percentage points a year lower, at about 3 percent, when inflation is accounted for.

“The ‘Fed era’ coincided with the U.S. moving from a rapidly growing economy to one that was both more mature and the largest in the world,” the Deutsche report said.

The Fed’s second century may start more actively than investors are assuming, the strategists said. That’s because it and other central banks may need to do more to boost nominal gross domestic product, which at a global level is the weakest since the 1930s when measured on a five-year moving average.

In the past six years, the world economy has potentially lost $41 trillion when its performance is compared to the pre-crisis trend, Deutsche said.

With asset markets performing better than economies, policy makers now may need to rethink how monetary policy is distilled and suspend quantitative easing programs, the report said. The biggest six central banks have spent $7.5 trillion since September 2008.

“Globally the next few years may bring politicians and central bankers closer together and monetary policy that directly targets growth over financial assets,” Reid and colleagues said. “Many global assets have been inflated by QE and central banks may need to spend the next few years engineering higher nominal GDP to justify such valuations.”

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Lehman Brothers Holdings Inc. was insolvent and U.S. authorities had good reason to let it fail, according to a new analysis of its accounts.

While the 2008 collapse of the then-fourth biggest securities firm helped trigger a financial crisis and recession, William R. Cline and Joseph E. Gagnon of the Peterson Institute for International Economics found the bank also lacked collateral to pledge in return for aid.

The assets it did have were of questionable quality and scattered across the world, they said in a report released last week to mark the fifth anniversary of the Sept. 15 bankruptcy filing. When Lehman filed for bankruptcy its net worth was as much as a negative $200 billion, they said.

Other institutions saved during the crisis, such as Bear Stearns Cos. and American International Group Inc. (AIG), were “arguably solvent” and so the Fed could better play its role as a lender of last resort, Cline and Gagnon found. European officials including then-French Finance Minister Christine Lagarde were among those to criticize the failure of the U.S. to save Lehman.

In a Sept. 17 entry on his blog, Brad DeLong, a professor at the University of California, Berkeley, took issue with the analysis, calling the bankruptcy a “disaster” that could have been avoided if policy makers had acted sooner to press Lehman into finding a buyer.

* * *

A tightening of monetary policy by the Fed isn’t a barrier to economic growth and employment, if history is any guide.

In six of the last seven periods of higher interest rates dating back to 1976, economic growth was still strong two years after rate expectations began to build, according to ABN Amro Bank NV economists including Peter de Bruin.

Private employment grew an average of 200,000 per month even though the 10-year Treasury note yield rose by an average of 160 basis points in the 180 days after each of the rate increases came to the fore, the Sept. 18 report said. Equities, commodities, the dollar and gold typically did well, it said.

ABN Amro’s baseline scenario is for history to repeat itself as the Fed begins tapering its quantitative easing program. The U.S. economy will accelerate in coming quarters and there will be gains in equities and the dollar, the economists said. A difference from the past is that commodities, especially gold, may face headwinds.

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The media’s importance to financial markets is reflected in what happens to trading when journalists strike.

A study of 52 national newspaper strikes in four countries between 1989 and 2010 found trading volume fell 12 percent on stoppage days and the dispersion of stock returns was reduced by 7 percent, said Joel Peress of INSEAD business school in Fontainebleau, France.

“These findings demonstrate that the media contribute to the efficiency of the stock market by improving the dissemination of information among investors and its incorporation into stock prices,” Peress said in a paper published this week by the London-based Centre for Economic Policy Research.

* * *

The U.S. could create a sovereign wealth fund that would be worth more than $3 trillion after two decades if it saved a portion of tax revenue from its recently discovered shale oil and gas reserves.

That would be about four times Norway’s fund, the world’s largest, estimate Stephen Jen and Joana Freire of SLJ Macro Partners LLP in London.

The argument for saving, as Norway did with its oil revenue, rather than spending income from crude, as the U.K. did, is the potential for greater investment returns. Doing so supports the wealth of future generations rather than the lifestyle of the current one, they said.

“Unfortunately, more likely than not, the U.S. will spend the tax proceeds from this energy bonanza,” Jen and Freire said.

* * *

German drinkers are unlikely to choke at higher beer prices at this year’s Oktoberfest, according to UniCredit Group.

Using data going back to 1980, economist Alexander Koch estimates an elasticity of demand for beer from one year to another during the festival of 0.3, which suggests price changes have little effect on demand.

“Beer at the Oktoberfest therefore falls into the category of Giffen paradoxes, which describes goods where demand increases at the same time as the price,” he said in a Sept. 17 report.

The annual event begins in Munich tomorrow. The average price of a “Mass,” or mug, of beer this year is 9.66 euros. That translates into an increase of 3.6 percent from a year ago, Koch said.

Combining transportation and food with the price of two beers, a visitor price index devised by Koch has shown an average annual increase of 4 percent since 1985, more than double the 1.9 percent rate of German consumer price inflation. Even so, beer consumption rose again last year, he said.

“Obviously, entering the Oktoberfest site and drinking a Mass makes Germans less price sensitive and reduces their inflation fears,” Koch said. “That definitely deserves a celebratory ’Prost!’”

To contact the reporter on this story: Simon Kennedy in London at skennedy4@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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