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Fed Might Take Backdoor Approach to Interest Rate Hike: Bill Greiner

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What is the variable that is going to drive a lot of activity in the capital markets over the next 3-6 months? Interest rates. But the question investors should be asking is not when the Fed will raise rates but how.

So says Bill Greiner, the chief investment strategist of Montage Investments, a subsidiary of Kansas City-based independent financial services firm Mariner Holdings.

During a visit to ThinkAdvisor’s New York office, Greiner discussed two of the major trends he sees affecting the U.S. economy in the near future: the current secular bull market and interest rates.

“I think the real key here going forward is going to be the interest rate market — what rates do, at least short term,” Greiner said. “That’s the variable that is going to drive a lot of activity in the capital markets over the next 3-6 months.”

Greiner called the Federal Reserve a “wild card.”

“Consider the real power players, all three are of the same mind,” Greiner explained. “[Fed Board Chair Janet] Yellen and [Fed President Charles] Evans in Chicago and [Fed President William] Dudley in New York — all three of those major power players in the Fed are all relatively dovish. If they can figure out ways to drag their heels on raising interest rates they’re probably going to do it. That’s their natural bias.”

This is why Greiner belives how the Fed is going to raise rates is much more important than when they are going to raise rates.

“How they’re going to start raising interest rates, I think is a real key,” Greiner said. “A lot of people haven’t really been focusing on that. People have been focusing on: Is it going to be in June or is it going to be in September?”

Greiner subscribes to the view that the Fed will start raising rates first on the reverse repo markets, a view that is just starting to gain some traction.

“The Fed’s first move may not be necessarily to raise rates on the discount rate nor the fed funds rates,” Greiner said.

A reverse repo, which Greiner calls an “arcane market,” is a lending agreement in which the Open Market Trading Desk sells a security to an eligible bank or money manager with an agreement to repurchase that same security at a specified price at a specific time in the future. According to the Fed, the difference between the sale price and the repurchase price, together with the length of time between the sale and purchase, implies a rate of interest paid by the Federal Reserve on the cash invested by the bank or money manager.

Greiner explained why he thinks the Fed would raise rates here first: “The Fed is really keen on the banking system maintaining its capital base. With that in mind, they may not directly attack — take the big hammer and start attacking — banks’ capital bases by raising discount rates and Fed funds rates. They may do a kind of backdoor approach to this, toward the reverse repo rate.”

The Fed has been discussing raising the daily size limit of its reverse repurchase agreements for some time and at its March meeting decided to lift the cap. According to the Wall Street Journal, this could mean that “a number of officials believe a higher cap, at least for a time, could help the central bank begin the process of rate increases, when the time comes.”

Secular Bull Market

As Greiner sees it, the U.S. equity market is currently experiencing its fourth secular bull market since 1920.

Secular bull and bear markets are major, multiyear affairs in which stock prices rise or fall over long periods of time — on average 13 years in duration, Greiner said.

Greiner believes the U.S. is in the sixth year of this secular bull market.

“People ask me, where are we in our secular bull as far as the road map is concerned as compared to previous secular bull markets?” Greiner told ThinkAdvisor.

The three previous secular bull markets happened from 1921-1929, 1942-1966 and 1982-2000.

“Historically, going back to 1900, it’s very common in the first three or four years of a secular bull market, there’s going to be some kind of correction phase,” Greiner said. “This time around, it happened in 2011.”

And according to Greiner, the price correction that occurred in 2011 following the bottom in 2009 was in line with the secular bull market that started in 1982. The severity and timing of this correction was not only similar to the correction in 1984, but also the stock price correction that happened in 1924.

After the price correction in a secular bull market, normally, Greiner said, a cyclical pullback in equity prices follows somewhere between the fifth and seventh year.

“This is where we are right now as compared to those other previous crashes,” he said.

During the cyclical pullback of the 1942-1966 bull market, the stock market was down about 23%. And, in the most recent secular bull market, the crash in 1987 had the stock market down 36%.

“If the secular bull is going to be similar to the two previous bulls, we shouldn’t be surprised to see the stock market move down by 10-20% in value sometime in the next year or so,” Greiner said.

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