Pub. 9 2018 Issue 2

Summer 2018 19 West Virginia Banker T H E F I N A N C I A L I N S T I T U T I O N E X P E R T S 248.548.8400 www.m-f-a.com Investment Portfolio Management · Asset Liability Management Merger Valuations · Mortgage Servicing Rights Valuation · Strategic Consulting Are you focused on Profitability? Cal l us to learn how our Portfol io Management and Asset Liabi l ity Management services can help you. Jeffrey F. Caughron is a Managing Director with The Baker Group, where he serves as President and Chief Executive Officer. Caughron has worked in financial markets and the securities industry since 1985, always with an emphasis on banking, investments, and interest rate risk management. Contact: 800-937-2257, jcaughron@GoBaker.com. magnitude of the burst typically mirrors the magnitude of the boom, and the boom hasn’t been very loud for this recovery. Nonetheless, Fed policymakers may find themselves having to go slower with their rate hikes than they previously planned if they want to keep the party going. This brings us back around to the yield curve issue. In the last four years, the shape of the yield curve has flat- tened substantially as the Fed has raised short-term rates while long-term rates have remained sluggishly low due to weak growth and a dearth of inflation. This effect is not lost on some policymakers. Dallas Fed President, Robert Kaplan, recently noted that the flatter yield curve has a limiting effect on Fed flexibility, particularly with respect to how far and how fast they can raise rates without choking too much growth out of the economy. In essence, policymakers must be cognizant of what the market is telling them about their policy stance and whether it’s appropriate for the underlying conditions. They ignore market signals at their peril. As Kaplan said, “The history of inversions is such that it has tended to be a pretty reliable forward indicator of recession. Now, this time may be different, but I wouldn’t count on it.” Kaplan is certainly not alone in sounding this alarm as the very same concerns have been expressed by his colleagues James Bullard in St. Louis and Neel Kashkari in Minneapolis. Still, the expected policy stance of the Fed is to raise rates three or four more times in 2018, presumably bringing the Funds rate to 2.25-2.50%. Now, if the yield on the 10-year US Treasury Note remains close to its late 2017 level of around 2.45%, then we’ll be facing a curve that’s flat as a pancake. At that point, it wouldn’t take much of a rally lower in the 10-year yield for the inversion to have begun, and Fed Funds will have reached its terminal rate for this cycle. So, we seem to be sitting at a point in the cycle where there’s plenty of good news coupled with plenty of future risks. It feels like it did in the beginning of 2007. Back then, mistakes were made on credit quality, funding choices, and security selection in the investment portfolio. Investment officers who were hun- gry for yield were sold high-risk private label mortgage-backed securities, TRUPs, and preferred stock, all of which ended badly in the crisis. Hopefully some lessons were learned. As always, today’s performance reflects yesterday’s decisions, and the returns we enjoy tomorrow are determined by the choices we make today. Like a chess match, bank manage- ment involves cautious and thoughtful consideration several moves ahead. At The Baker Group, we like to say “Anticipate, don’t predict.” 