Could the Fed’s new policy changes signal the end of the bull market? There is a often quoted saying: “Don’t fight the Fed.” If that is the case, perhaps it’s time to step back and analyze exacting what took place this week. The Fed uses two ways to communicate with the public. It holds eight meetings each year. The Chairperson, in this case Janet Yellen, issues a consensus statement on overall Fed policy and issues some guidance going forward. The second and equally powerful communication comes from the minutes of the Federal Open Market Committee (FOMC) whose job it is to oversea the Fed’s market operations and steer interest rates in line with committee consensus.
How the Fed Controls Interest Rates
The Fed controls the all powerful Fed Funds Rate. Banks must deposit funds with the Fed to meet their reserve requirements. If they have excess funds they can lend them out to other banks and large institutions.
However, it is the Fed that has the powerful silent hand in controlling the Fed Funds rate. The FOMC can add money to the system by buying treasuries from the banks and crediting their bank balances. Banks then have more money to spend and interest rates remain low. On the flip side the Fed can limit the money in circulation by selling securities to the banks, thereby draining funds from the system. This has the effect of raising interest rates and a slowing of the overall economy. At present the Fed Funds rate is set at 0 to .25%. To add to mix we have futures contracts on the Fed Funds rate. These are three month contracts that project the funds rate into the future. Bankers and investors watch the contracts carefully to garner any hint of a rate increase. At present the nearest contract is at .25%, the August 2015 contract is at .50% and the December contract is at .75%.
Fed Policy Changes
On March 19, 2014, Chairperson, Janet Yellen, held her first news conference. She stated that the Fed was removing the 6.5% unemployment from the Fed’s guidelines. She prefers not to have a specific number to determine interest rates. Then, when a reporter asked when the Fed planned to raise rates, she made an “off the cuff” startling remark. She said that the Fed could raise rates perhaps “six months” after the end of Fed tapering. Within minutes the stock market tumbled. Fed watchers estimated that Fed tapering would end this fall. Projecting out six months brought the rate hike to April 2015.
The FOMC minutes also revealed a startling change in their rate projections going forward. They see the Funds rate at 1% by the end of 2015 and 1.75% by the end of 2016. This was quite shocking since the consensus was for .75% and 1.75% respectively. Now add to this another piece of disturbing news. 13 of the 16 policy making members favored a rate hike sometime next year. One member wanted it this year, and two others preferred to wait until 2016.
Make no mistake, these policy changes will affect the markets. No one knows for sure the exact outcome but it is time for investors to be vigilant and keep a watchful eye on the Fed.