Known Unknowns


Welcome to Known Unknowns, a newsletter originally about pension risk but has expanded to macro/financial trends, too, because 1) it is important and 2) no one wants to read my rants about pension discount rates every other week.

The Fed

As you may have heard, the Fed did not change interest rates last week. But if you squint hard enough, you’ll see that it promised to cut rates in July. I’m not buying it. Now, I am too much of an efficient markets person to make a prediction. If there’s a negative shock the Fed will probably cut rates. But if the economy keeps humming along, I am not sure what the justification is. And if you believe two things:

  1. The Fed mandate does not include propping up the stock market

  2. There are costs as well as benefits to low interest rates

then, it is not clear why the Fed would cut rates. Megan Greene points out there’s not much ammunition left from low rates. Ruchir Sharma is worried that low rates are starting to have a negative impact. The Fed funds rate is currently 2.5%ish. If there’s a 50 basis-point rate cut (as some predict), that’s a 0% real rate, when the economy is growing and unemployment is below 4%. So why cut rates? Some iffy manufacturing numbers? Some weird theory that claims low rates are an “insurance” policy that will stave off a recession caused by real economic variables.

When did economics journalists decide all non-employment is cyclical?

Predictions of Fed rate decisions are usually wrong, probably because they include lots of wishful thinking among investors with short-term interests. But the Fed is playing the long game—or we hope it is.

California Pensions

There are many reasons why public pensions are in trouble. If you ask me, politics and pension accounting don’t mix. Neither does investing. Politicians say things like pension assets should finance public works projects that benefit the community—or be invested in things that reflect enlightened values. Incidentally, is this where the fiduciary standard is heading?

Here’s what I think the objective is of public pension funds: They should invest with the goal of paying their liabilities while taking only as much risk as necessary (within reason). Crazy right?

Well, California is not so sure; it also wants to support certain types of companies. But the state’s social impact investing has not been doing so well. Now it’s facing an existential crisis about what the purpose of investing is.

Is it really that hard?! I say its mission includes not chasing the latest fad and sticking the tax payer with the bill.

Bond Market Goes Algo

The FT reports that the algos are coming for the bond market. Personally, I am an algo agnostic. I reckon they make markets more efficient (which is good) and lower spreads (also good), but any new technology poses risk and unintended consequences (not so good). Algorithms are also written by humans, so they reflect all their issues or have bugs (not great, but still probably better than humans).

In the past, bugs have caused market volatility, but markets normally recover by the end of the day (+1 for EMH)—so unless you are an active day-trader trying to beat the market (and you probably shouldn’t be), it is not the worst thing—at least in the equity market.

But what will it mean for the smaller, less liquid, more systemically risky bond market? I am not sure. But it is something to think about.

Data Reliability

Not a week goes by without a high-profile debunking of some well-cited statistic. In the last few weeks, the fact that 3.6 million Americans live on $2 a day number was proven wrong. The single people are happier argument was revealed to be based on a rookie error with the American Time Use Survey—and let’s not get started on the Americans can’t cover a $400 expense talking point.

I am not sure there’s anything new here. People have always bended numbers to make a point, sometimes went too far, and were corrected. But now that data is more accessible, everyone has a social media account, and we live in a political atmosphere that encourages both exaggerating data and humiliating people who disagree with you—it all happens more frequently and in a public way. We are all living in a never-ending economics seminar.

Which is good. People should be held accountable. But I worry. No one trusts the news any more, but at least we had data to ground us to reality. But if we abuse it—will no one trust numbers or science anymore? Did they ever?

In Other News

The Economist has a nice story on Bob Merton and the fallacy of time diversification
It also wrote a blog post that mentions my book
Public pensions exacerbate the business cycle

Until next time Pension Geeks (and our friends)!