Fed's Tougher Task Shouldn't Knock Investors Off Target

The Federal Reserve faces a tougher task than usual when it pulls up around the conference table this week. The challenge of the Fed’s next chapter extends to long-term investors who’ve spent the better part of the year thinking and rethinking the next course for interest rates and their portfolios.

No one’s denying that these volatile market conditions are stomach-churners. But they shouldn’t knock investors off a focus on company fundamentals and the Federal Reserve’s need to wean the U.S. economy from extraordinarily low interest rates—an act that will mark the Fed’s stamp of approval on a healthy economy.

For sure, the Fed and the investing masses are watching wild global stock market swings chew up short-term stock charts. Many wonder if lost wealth and waning consumer confidence carry the potential to derail an already vulnerable economy in China, Europe, and other growth pockets. Former Treasury Secretary Larry Summers has said that China—a huge customer in the U.S. bond market—may return funds home. That exodus would push down bond prices and push up yields (aka interest rates), essentially doing some of the Fed’s heavy lifting.

Debate Deepens
It’s an ill-timed dilemma that lands Fed policy-makers in a pickle. During the aggressive stock sell-off week in late August, New York Fed President William Dudley seemed to close the door on a September rate hike, saying it looked “less compelling” based on market turmoil. But Fed Vice Chairman Stanley Fischer suggested that markets might calm down quickly, setting up a rate decision largely independent of short-term market swings.

Stock market analysts and economists are also reacting to market changes as they try to handicap Fed rate-hike odds at the September 16–17 meeting. Just to name a few: Barclays now thinks the rate hike will be in March, not September; S&P Capital IQ’s Sam Stovall still finds a strong likelihood the Fed may pull the trigger on a quarter-point hike this week, but he acknowledges fresh uncertainty with the market slide.

In the throes of stock chaos, Fed funds futures traders sharply marked down the probability of a September increase in the Fed’s short-term target rate. Odds were at slightly better than 50-50 in early August, but at one point during the late-August stock scamper, those odds were close to 20%. Short-term adjustment, yes. But are futures markets still priced for higher rates early in 2016? You bet.

Why Think Short Term Now?
It’s true that traders and the buy-and-hold legions can’t ignore stock moves of the magnitude that gripped the globe in late August and early September. But it’s also true that the underlying economic fundamentals, corporate climate, and the Fed’s already telegraphed go-slow approach for pushing up near-zero interest rates hasn’t changed—or at least, hasn’t changed all that much.

The Fed was already dealing with spotty conditions regardless of market performance. “Last week's rout appears to be a delayed reaction to several developments: recent softness in credit markets, the sell-off in emerging markets, and general concerns over the state of the global economy,” said Russ Koesterich, BlackRock Global’s chief investment strategist. “Recent U.S. economic data have generally been encouraging, but it is worth highlighting that much of the data have been consistently below expectations for most of the year.”

Remember, for long-term investors and the economy, interest rate policy is not a fine tool. It usually takes between six and 12 months for the economy to feel the stimulation effects of lower rates. It also takes time for the economy to slow down as a result of higher rates. All told, any shift in economic fundamentals—and the fundamental decision-making at the Fed—may not have changed as much as shell-shocked stock investors suppose.

Further Reading
Here, we revive some summer posts—a collection of Ticker Tape articles aimed to unlock some of the Fed’s thinking and prep stock and fixed income investors for a gradual shift toward higher interest rates:

Market Reactive: Hike Rates Now? Fed Mystery Alive

The Fed is in a policy jam. The rates-setting bank of banks is stuck between signs of improving U.S. economic fundamentals and the uncertainty sparked by a global stock sell-off. Investors are caught up in rates uncertainty, too, as no clear message came down from the mountain.

Retail Sales and Fed Policy: Is the U.S. Consumer Spending?

The Federal Reserve is impressed with job market improvement, but wants more concrete evidence that confident workers are spending on homes, cars, and other big-ticket goods. Why has the consumer been so hard to pin down, and what tools can help investors figure out consumer behavior?

See Ya, 0%—What Rising Rates Mean for Bond Investments

While global growth snags leave most other central banks loosening their monetary policy as mid-2015 nears—including Europe’s and China’s—the U.S. appears willing to nudge short-term rates up from the unprecedented, effectively 0% short-term Fed funds target that’s been a fixture in fixed income markets.

Remember CDs? Interest Rate Hikes Could Unlock Demand

Rising interest rates are generally positive for buy-and-hold fixed income investors and anyone trying to collect a little interest on savings, certificates of deposit (CD), and money market accounts. The rise of rock-bottom interest rates could revive demand.

Feeling Sensitive? Interest Rate Hikes May Tickle These Sectors

Tighter interest rate policy is bullish for the broad market, even if it’s met by a collective grumble on Wall Street. It means the Fed is confident in economic growth. Of course, some stock sectors are more sensitive to interest rate changes than others.

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