Time to move on from ZIRP

January 15, 2015 05:28 AM

CME Group named former Federal Reserve Board Chairman Ben Bernanke its 2014 Melamed-Arditti Innovation Award  (formerly the Fred Arditti Innovation Award) winner. I was somewhat surprised to see this as the financial community is relatively split on the performance of Bernanke, and the success or failure of his policies are not fully adjudicated. The jury is still out on Bernanke’s tenure as the Fed has not unwound its balance sheet from the extraordinary measures he took. 

It was a bold choice and we commend the CME for it because it acknowledges the truly extraordinary crisis that the country—and Bernanke as head of the Fed—was facing. Those who criticize Bernanke’s choices have that right—we have criticized some of the choices the Fed has made in Futures’ blog—but those who would pretend that what he was facing was just another run-of-the-mill economic downturn are attempting to rewrite history. In “Experts give Bernanke an A+,” Gibson Smith and Sheryl King—who provide  analysis on interest rates and the Fed in “Ask the experts”—give some perspective on what Bernanke was facing. 

Ironically, I was on a plane headed to Naples, Fla., for the first annual CME Group Global Leadership Conference on Sept. 15, 2008 when the credit crisis hit a critical mass with the bankruptcy of Lehman Brothers. 

Fortuitously, CME had former Federal Reserve Board Chairman Paul Volcker as the first keynote speaker at the event. Volcker at that time said, “We have a failed financial structure [which] has been held together by extraordinary official acts. Actions that are unprecedented and go to the edge of their legal responsibility.”

It is important to note that Volcker made those comments regarding unprecedented extraordinary acts on Sept. 15—the day many people see as the start of the crisis. We all need to remember that this crisis was years in the making and Bernanke had been managing the crisis prior to Sept. 15, 2008. 

Illustrating that is Hugh Donahue’s story, “Re-energizing the moribund bond market”. In it he speaks to the “broken” bond market and offers the concept of Interactive Finance. He, along with a white paper from asset manager BlackRock, discusses liquidity problems in the bond market. The BlackRock white paper makes the point that liquidity has not returned to the corporate and mortgage-backed bond markets to pre-crisis levels. 

In “Time for bonds to move,” Andrew Wilkinson discusses the myriad of factors that will press on the fixed income markets as the Fed prepares to move from this long period of zero interest rate policy (ZIRP) toward something approaching normal. Obviously “normal” is a relative term here, but we have seen during recent years that the market tends to overreact in anticipation of Fed activity. 

More than a year ago, Wilkinson pointed out how tapering was not tightening and that the bond market could still be a two-way market as the Fed negotiated the tapering process. He was proven to be correct, and it’s likely that bond markets will move in fits and starts as economic data changes the markets’ expectations as to when the Fed will pull the trigger and by how much. 

A point Wilkinson had made back in the July/August 2013 issue of Futures, which was reiterated by Smith and King in “Ask the Experts,” is that the Fed does not have to sell off its book, but can simply allow its large holdings of Treasuries and mortgage-backed securities to mature. However, just as they don’t have to sell off all those securities, they don’t have to hold on to them either. 

During the crisis, as interest rates hit zero, a common concern voiced by market watchers was that the Fed would run out of bullets to affect economic conditions if its policy prescriptions did not work. By having this massive book of assets, Bernanke has left his successor, Janet Yellen, greater tools to manage the next phase of the crisis. If inflation does spike, she could sell these assets and not be forced to only rely on the Fed funds rate, which would be difficult to take from near zero to a level that would dampen an overheated economy. Perhaps Bernanke was looking down the road further than his critics have realized. Steven Beckner analyzes the dilemma the current Federal Open Market Committee (FOMC) members face this year in “Countdown to interest rate lift-off”

To paraphrase Mark Twain, rumors of the demise of the 30-year plus bull market in bonds have been greatly exaggerated, but at some point — as we are seeing with crude oil — long trends end. 

Speaking of crude oil, Tim Fligg (see “Is an oil black swan looming?”) points out that U.S. shale producers may have more room in terms of its cost of production, and OPEC members may not have as much flexibility than in the past. Phil Flynn warns (see “Crude oil and the economic cycle,”) that just as high prices cure high prices, the current lower prices will cure themselves as well. Ashraf Laidi (see “Energy FX after the oil spill,”) points out that the rout in crude oil will also have an impact on forex markets. 

The dramatic move in crude oil and the anticipation of movement in fixed income will play out over all market sectors, which should make 2015 an interesting year full of opportunities for traders.


E-mail me at dcollins@futuresmag.com@Futureswriter

About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.