Fed Obsessions

What effect does the Fed have?

Poster from 1880s. Source: Wikimedia

For years we’ve obsessed about the Federal Reserve. Whether we picture the Chair as a heroic figure fighting off the forces of darkness and doom, or see the Fed as the center of a global conspiracy to enact vicious cycles of ruin, or view Fed staff and officers as primarily technocrats overseeing the country’s banking and monetary system, the Fed is at the center of a lot of our thinking.

And a lot that is justified. The Fed sets short term interbank interest rates, which influence all kinds of other interest rates. They also buy and sell US Treasury and Agency securities, all in an attempt to manage inflation and the real economy. And interest rates are a key input when we value any financial asset.

Treasury rates and the economy. Source: Aswath Damodaran

The Fed can influence long-term rates by virtue of its credibility. If market participants believe that the means what it says – i.e., that they will adjust rates to influence inflation – then the Fed has the same kind of impact as the Wizard of Oz: they have power because people believe they have power. For 20 years, from 1960 to 1980, the Fed allowed inflation to accelerate and interest rates to rise by trying to fine tune the economy. Paul Volker changed that, with his adoption of monetary growth targets.

For the next 20 years, the Fed’s primary task was to quell inflation. Falling long-term interest rates put a tail-wind behind the stock market. Lower rates meant that the present value of corporate cash flows was higher. Now we face a new era: not as accommodative as the ‘60s and ‘70s, but not as restrictive as the ‘80s. Newly confirmed Fed Chairman Powell made it clear in his testimony before Congress that he believes that the economy has fundamentally strengthened and that the Fed would continue on its course of normalizing policy.

When fundamentals change, the markets take some time to adjust, and things can get a little bumpy. Rising rates don’t necessarily mean the market has to fall, if they’re part of an improving economy, as they were in the ‘90s. The Fed is just part of the picture. They’re not heroes, they’re not monsters, they’re not the lead. At best, they play a supporting role.

Douglas R. Tengdin, CFA

By |2018-03-09T07:14:23-04:00March 9th, 2018|Global Market Update|0 Comments

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

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