Market Beat: Keep an eye on Federal Reserve policy
October 18, 2017
Monetary policy can have an impact on stock and bond prices. The Federal Reserve Open Market Committee (FOMC) has been embarking on a tightening cycle that should affect interest rates.
They have indicated that another increase in the Fed funds rate could happen again this year at their final meeting of 2017 in December. They will probably raise the rate by 25 basis points or bips. Twenty-five basis points is equal to 0.25 percent. They have also said that there could be three more gradual rate increases in 2018.
The number and size of the rate increases that we'll actually see are data dependent. It will depend on economic factors like inflation and employment. The mandate of the Fed is to provide price stability and full employment.
They have an inflation target rate of 2 percent annually. One tool that the Fed uses is known as the Philips Curve. The Philips Curve suggests that inflation will kick in as the unemployment rate bottoms out.
This month they also began doing some further tightening through a process referred to as quantitative tightening. They are reducing their balance sheet by $10 billion dollars per month, and plan to increase that rate by another $10 billion each quarter. The balance sheet is currently over $4.5 trillion dollars. The tightening process should lead to higher interest rates.
Another thing to watch after the December meeting is who will be appointed as Fed chair after Janet Yellen's term has expired. Her term will end in February 2018. President Trump has interviewed a few likely candidates already. We'll have to wait and see who the next chairperson is and see how hawkish or dovish their philosophy is. Hawks generally favor higher interest rates, and doves prefer lower rates.
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Over-tightening by the Fed could lead to a recession. According to the Wells Fargo economic group, whenever the Fed Funds rate rises above the low yield for the cycle of the 10-year U.S. Treasury note, a recession has resulted 70 percent of the time and the average lead time is 17 months. In the event we see another rate increase at the December meeting, the Fed Funds rate will exceed the low point of the 10-year Treasury yield.
We'll have to monitor Fed policy pretty closely over the next year or so to determine the impact on the economy and the markets.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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