Investors Seek the Fed’s Guidance on the Economy

What do the latest Fed minutes tell us? Since the recession began, the Fed has set two goals for the economy. Perhaps the foremost objective is to maintain inflation at or near the 2% level. The one crisis point would be a drop in inflation below the flat line. This would indicate that the economy is teetering on the brink of recession. The entire quantitative easing program is aimed at keeping the economy growing. We are seeing the effects of stagnation in Europe with the introduction of negative interest rates to stimulate the economy. So far, the US economy has been expanding, albeit very slowly. The latest 2nd quarter GDP numbers came in better than expected at 4.6%. The media has jumped on this number and is prodding the Fed to raise interest rates. However, all is not that great. The 1st quarter GDP actually fell 2.1% after a brutally cold winter in the Northeast. When taken together these numbers indicate a moderate expansion in the economy. According the Fed’s statistics, inflation in August was at 1.7%. However, this number does not include food, energy and shelter.

A secondary factor in maintaining inflation near 2% is the housing sector. Since the housing bubble burst, house prices have had a ragged and slow upward climb, but have not regained their past equilibrium. With the explosion of foreclosures in the early years of the recession, speculators jumped on the low prices and snapped up properties on the cheap. This seems to be slowing considerably and growth is slipping somewhat.

The second major goal of the Fed is to foster maximum employment. The recession hit at a particularly bad time when businesses had already set in motion movements toward the increased use of technology. This had the effect of cutting out a large segment of higher paid workers from the workforce, many of whom have not been able to find employment at their skill levels. Many have had to take lower paying jobs, or part time jobs. Chairwoman, Janet Yellen, has repeatedly stated that the labor market still has some slack and therefore favors continued low interest rates. The numbers bear this out. At the lower end of the labor market, wages have actually declined by 5%, while the top 28% of managers and tech workers have seen steady increases in salaries.

The Federal Open Market Committee (FOMC) that sets monetary policy has stated the Fed will continue to keep the Fed Funds rate at 0-¼% for a considerable period, even after they see the two goals mentioned well underway.

The Fed will end its latest round of quantitative easing by the end of the year. However, it left the door open for future easing if conditions warrant it.

The Fed will continue to reinvest the proceeds from their bond purchases at auction.

For investors this means a “steady as she goes” policy. Now, it will be the performance of the economy in terms of GDP, housing prices and employment going forward that will weigh in on stock prices. There are many variables, both international and domestic that will determine growth going forward. The US is slowly moving toward a wartime economy. This will change the “business as usual” scenario that we’ve had up to now. This is where investors must adjust portfolios to meet the rapid shift in business conditions.

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