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The Federal Reserve, Animal House & Bugs Bunny

The Federal Reserve, Animal House & Bugs Bunny

April 14, 2020


Much to my wife's bewilderment and dismay, Animal House remains one of my favorite movies. I first saw it on cable TV when I was probably much too young to have had that freedom and choice. I have seen all or parts of this movie dozens of times. Rachel will attest that if it is on, I have to stop and watch at least a few minutes, every time.
 
There are many funny scenes and classic lines that we sometimes quote at the office. One of my favorites is after the fraternity brothers all get kicked out of Faber College. Bluto, played by John Belushi, is laying on the floor, staring at the ceiling and says, "Seven years of college...down the drain".
 
After the great financial crisis of 2007 - 2009, when AIG and Lehman Brothers failed, the Federal Reserve Bank, the Treasury Department, and the government took massive steps to bail out or rescue multiple banks and companies. This included cutting interest rates to 0% in December 2008. Interest rates remained at that artificially depressed level until December 2015 when an attempt was made to begin raising them.
 
Over the next three years, the Fed raised interest rates a total of nine times. The Fed Funds rate got as high as a target range of 2.25% - 2.5%. The Fed also tried to reduce the size of its balance sheet by selling bonds that they had purchased during the great recession to help lower longer-term interest rates. This was known as quantitative easing. It was a long and hard road and there were multiple periods of volatility as the Fed attempted to go down this path. 
 
There were two main purposes in trying to normalize interest rates, when the rest of the global central banks were not:
  
   1) Wean the economy and the markets off the medicine of artificially depressed interest rates.
 
   2) Reload the gun so that the Federal Reserve Bank would have ammunition the next time we went into a recession.
 
Historically, whenever we entered a period of recession or dislocation in the markets, one of the first things that the Fed would do would be to lower interest rates to spur economic activity.  To encourage people to buy automobiles and homes, and companies to invest in plants, equipment and technology. In December 2015, with interest rates still at 0%, the Fed had no ammo in the gun to fight the next battle.
 
As of December 2018, the Fed had loaded nine interest rate increase bullets in their gun of monetary policy. At that time, the Fed was promising that they would raise interest rates multiple times in 2019. This caused a bout of volatility in the markets in the fourth quarter of 2018, so the Fed acquiesced and decided on a wait and see approach. Subsequently, during a period of concern about presidential impeachment and trade/tariff issues with China, the Fed cut interest rates three times in the late summer and early fall of 2019. A complete about face of monetary policy in record time (3 bullets fired).
 
Now, in the last six weeks the Fed has cut rates by 1/2% (2 bullets fired), and then an additional 1% (the LAST 4 bullets fired) a couple of weeks later. All of this as we are just entering a COVID-19, coronavirus induced recession. Bugs Bunny would often fool Daffy Duck by saying that Elmer Fudd had "no more bullets". Like Elmer Fudd, the Fed now has no more bullets.
It may not be seven years of college down the drain, but it was four years of scrapping and fighting to normalize monetary policy AND remove the artificial sugar high of abnormally low interest rates. Now, all of the ammo that was loaded over those four years went down the drain in a mere eight months.
 
We will have to stay tuned to see what happens next. It is a story that not many people are aware of or understand its importance. However, we are paying an enormous amount of attention to the impact of these policy decisions. We need to understand how these issues may impact the economy and the markets and our clients' portfolios in the future as we continue "Moving Life Forward" together.
© 2020 Jesse Hurst