Fed Changes the Rules
May 31st, 2016 | Work to Wealth
The April Fed update, following the conclusion of the FOMC meeting on April 27th, commented on the market pricing in a 51% probability of a rate increase in December. The expectation was for only one rate increase for the year, despite the FOMC’s plan for four rate hikes in 2016. Fast forward just two weeks to May 18th to the release of the actual meeting minutes from April 27th and an entirely different story can be told. The minutes of the same meeting lead the markets to the opposite conclusion about the future of rate increases, that rates were likely to be increased as soon as the June or July meeting. This resulted in a dramatic decline in the stock market, an increase in the US Dollar, and a decline in oil prices. Randal Jenneke, Sydney-based fund manager at T. Rowe Price stated “the Fed has changed the goal posts so many times, everyone is confused. No one knows when they’re going to raise rates and no one knows what’s going to be the key thing to trigger the decision.” That type of policy uncertainty is not well received by nervous market participants trying to determine the proper course of action in the unchartered waters of ZIRP (Zero Interest Rate Policy).
Since then, markets have been pricing in interest rate increases as a positive for the stock market, the US Dollar and economic growth. On Friday, Chair Yellen participated in a Q&A at Harvard providing further insight into the timing of upcoming interest rate increases and the focus of the FOMC. Some highlights include, on one hand, her view of a continuing improvement in the economy, but on the other hand, a focus on systemic risk and financial stability, stating “we want to do everything to head off a financial crisis” and that “[we] don’t have typical scope to cut rates in case of shock”. With that, she also commented that a hike in coming months may be appropriate. It can then be inferred that a cautious FOMC is actively trying to raise rates in what they view as an improving economy, but with a watchful eye on a possible economic crisis. A major concern is with their inability to use rate cuts as a policy tool due to rates already being close to zero. The FOMC’s strategy sounds optimal, however the proof will certainly reside in the delivery. While the first quarter’s dismal GDP numbers were followed up by the second quarter’s positive figures, market interest rates have already ticked up in anticipation of the June/July rate hike without the FOMC taking any real action.
To reinforce the important point highlighted in the April Fed Update, the commentary and chart below are included again.
Why is it so important to pay attention to FOMC policy decisions? Does an investor really have to consider how they should invest their retirement money based upon whether the Federal Reserve is going to affect the interest rate charged to banks? The short answer is yes. The longer answer is a bit more involved, especially during these unprecedented times of zero percent interest rates. Below is an interesting chart that may help shed some light on this unusual time in history.
Perhaps because Fed policy has shaped the entire stock market gain the past 18 years. This Ned Davis Research chart shows that the actual S&P 500 price since mid-1997 (red line) is double the S&P 500 price if we exclude 300 Fed meeting days (blue line) [150 meetings, so exclude 300 trading days including the day of and the day before of 4,708 total trading days since 6/30/97].
Source: Barry B. Bannister, CFA Stifel Equity Strategy firstname.lastname@example.org
At DeCesare Retirement Specialists we prioritize safety of capital above growth opportunity during volatile times. We continue to employ counter risk measures alongside a prudent growth strategy in order to protect capital in what continues to present as a challenging economic and investment environment.
Should you have any questions and/or concerns about your accounts with us or outside of our management, please call me at 856.235.3830 or email me at Steve@DeCesareRetirement.com.