Market Overview

The Fed Is Performing Surgery With A Sledgehammer

The Fed Is Performing Surgery With A Sledgehammer

As markets continue to grapple with recent stagnation and the turmoil of Brexit, the Federal Reserve’s responsibility to facilitate stability and economic growth is critical. As we speak, austerity and political gridlock have fiscal policy in a choke-hold, making monetary policy the only game in town with respect to jump-starting growth. Yet the Fed’s ability to influence the market and spur growth depends importantly on how and when it communicates its policy decisions to the public.

Unfortunately, the Fed’s recent communications and decisions, including July’s announcement to hold rates, reflect a shortsighted approach to monetary policy that is both unpredictable and confusing for investors, ultimately creating more uncertainty in the markets, delayed business decisions, and less economic growth. Moving forward, we hope that the Fed communicates a consistent policy with a long-term focus that will bring certainty to the markets.

Over the last year, the Fed became too unpredictable, making shortsighted decisions under the guise of responding to economic data. While the Fed should take into account financial conditions when determining interest rates, it is placing too much importance on short-term fluctuations and employment reports.

For instance, after hinting that rate increases could be imminent, the Fed immediately backed away from rate hikes after a weak May employment report. At the current low level of rates, this attempt to fine-tune monetary policy over a period of mere weeks is dangerous and undermines the potential long-term effectiveness of the policy—it’s akin to performing surgery with a sledgehammer. Historically, the Fed operated under the expectation that it would take six to eight quarters for the full impact of monetary policy changes to be felt in the real economy. The current leadership should return to this longer view perspective.

In addition, the Fed is over communicating with the public, providing inconsistent and conflicting guidance that only increases uncertainty. Individual investors are witnessing too much of the Fed’s internal deliberation without sufficient explanation or a sense of its long-term timeframe, which would give context to its statements.

For example, the difference between the April Federal Open Market Committee’s statement, which offered no hint of near-term rate increases, and the minutes of that same meeting released in May, which suggested a rate increase might be imminent, was jaw-dropping. These frequent mixed messages from the Fed are causing investors to adopt and reverse positions more frequently than they should, further obscuring the true health of the underlying economy.

The July announcement further spotlighted the Fed’s confusing approach, as it maintained rates in response to the uncertainty of Brexit, despite earlier indications of rate hikes. However, the financial conditions that the Fed looks at when assessing whether to raise rates, including the interest rate on government bonds, credit spreads for corporate bonds, and the level of the equity market, were roughly the same leading up to the July announcement compared to the time period just prior to the interest rate increase in December 2015.

The Fed should clarify its approach and communicate a long-term policy that will provide much-needed certainty to the post-Brexit markets. When communicating any decision on interest rates, the Fed needs to connect to expectations for longer horizon data (one to three years) rather than changing course based on month-to-month data.

This will make the Fed’s policies and impact more effective, while also eliminating back-and-forth prognostications that confuse investors. By changing its outlook and communication style, the Fed can foster confidence in its approach and, by extension, the economy and financial markets, even in the tumultuous times that we live in.

Jason is Chief Executive Officer & Chief Investment Officer of Savos Investments, a division of AssetMark, Inc.

Posted-In: News Global Opinion Economics Federal Reserve


Related Articles

View Comments and Join the Discussion!