The Independent Market Observer

Fed to Market: Full Speed Ahead

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jun 19, 2014 10:38:00 AM

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FedThe Federal Reserve’s announcement yesterday that it would continue its current tapering schedule—but that a rise in rates still isn’t imminent—drove markets to the 20th new high of the year.

Fed meeting highlights

The board lived up to expectations by cutting stimulative bond purchases by another $10 billion per month, from $45 billion to $35 billion. They did so despite weak first-quarter economic data, indicating that members believe the economic recovery remains on track. They also signaled that the measured reduction of $10 billion per meeting was likely to continue, which would wrap up the Fed’s bond purchasing by the end of the year.

The agenda for interest rate hikes, the next step in the process, was essentially unchanged from prior meetings; although perhaps slightly more aggressive, it wasn’t enough to really move the needle.

What about this news bumped the market?

Two things, I think:

  • Most important in the short term is the Fed’s slowing estimate of economic growth and declaration that inflation isn’t currently a problem. Slower growth and low inflation both point to continued lower rates, one of the driving forces behind this bull market. Lower for longer on rates means higher for the stock market.
  • The other factor, which will probably mean more over time than it does today, is a relatively subtle change in the median estimate for the long-term fed funds rate, which dropped from 4 percent to 3.75 percent. This sounds esoteric, but it means that the Federal Reserve as a whole is now more likely to keep rates lower permanently. That’s a really big deal. Lower rates, even by only 25 basis points, can support higher asset prices, more borrowing, and faster economic growth.
What’s the takeaway from the meeting?

The recovery continues (good for the market), but not so quickly that the Fed wants to remove the stimulus sooner than expected (also good for the market). In fact, the board is now indicating that they want to keep a more stimulative interest rate policy indefinitely, which is very promising.

Overall, the real economy continues to normalize, and the Fed will likely keep giving the asset markets a push for quite a while. No wonder the markets cheered.

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