Fed More Divided on Interest Rate Hikes Than We Thought

Federal Open Market Committee

It turns out that the Fed being patient with interest rates at this point in time doesn’t mean that all members feel this way. This really shouldn’t matter to us much though.

The minutes of the January meeting of the Federal Open Market Committee was released on Wednesday, and it has provided us with a better and perhaps a more divisive view of the economy than the announcement at the time led us to believe.

While open market committee announcements involve providing us what the consensus view of the Fed is at the time, people don’t always completely agree, and looking at the minutes of these meetings can provide us with a better feel of how the committee may be leaning as well as learning more about the sentiment that is behind the decision as well as their degree of tolerance.

The Federal Reserve Bank of the United States, or the Fed as it is commonly known, is the country’s central bank whose primary task is to essentially manage the economy by taking actions that seek to mute the normal boom and bust business cycle, and better ensure that we pursue courses of overall prosperity that are fairly consistent.

There’s only so much a central bank can do, but they do have some pretty powerful tools at their disposal, and are powerful enough that stock markets pay very close attention to both their actions and their commentary, often hanging on every word.

Essentially, the Fed has their foot poised over both the gas and the breaks of the American economy, putting their foot on the gas by pursuing more expansionary policies when the vehicle is running too slow, as well as applying the brakes when the engine runs too hot and inflation becomes more of a concern.

Given that the economy on its own tends to grow more than it contracts, the breaks tend to be used more often. In spite of the bout of economic slowdown that the country is suffering from a bit, they have used the breaks as recently as last December, and while this wasn’t done in the January meeting, from reading the minutes, there are several committee members who have their feet poised to slow us down more.

How the Fed Stabilizes the Economy

Stock markets like fast moving economies, and don’t really care for this breaking, and this is why when the Fed decides to intervene on that side, stock prices go down. Stocks are being held for, among other things, expectations of growth with the businesses they own, and business owners generally don’t like the cost of doing business going up or their sales being beat down by efforts to contract their markets.

The Fed is therefore more like a parent to the economy, where if you let the kids run wild you can end up with a real mess on their hands, which is what excessive inflation rates could be called. Inflation devalues the monetary value of everything, and while a little of this is seen as OK and healthy, too much can cause too much devaluation.

The risk here isn’t just runaway inflation, like we see in Columbia, although runaway inflation can lay waste to an economy and is to be prevented at virtually any cost. Less severe but still too high inflation rates cause damage as well even though of a lesser extent.

An easy way to envision this is to take someone who has $50,000 in savings and $100,000 invested in the stock market, as well as a job. If we see a year with 10% inflation, we can be fooled into thinking that the great return that we got on our investments sure looks good, although we need to deduct this 10% from it.

We also need to deduct this amount from the $50,000 we saved up, less our return, and returns in savings are generally pretty small and generally below inflation rates. As inflation rises, the gap between our returns and inflation increases, resulting in a loss. This also happens to the money we earn from employment, and while we do get raises, higher inflation also outpaces this generally.

Inflation Can Really Be a Beast

Keeping inflation in check is more far reaching than this, but it does affect us all in a fundamental way, serving to reduce our personal wealth directly. This is therefore far from just a high-level economic concern, even though it very much is, as it’s also a worry at the grassroots level and affects everyone.

Stock markets still love low interest rates and other expansionary measures and still hate measures that look to shrink things, but it’s not as simple as just looking at this as things stocks like or don’t like if you are invest in them.

The net effect is what matters here, and stocks liking certain things may drive up their prices, but if such a thing also devalues the price of the stock by way of inflation, we need to look at the net effect of this. Sometimes we can see stocks moving up nominally while their value net of inflation can actually go down.

Stock markets are marvelously efficient, and is far from just a stimulus-response mechanism, pricing events as they occur. Instead, future expectations are priced in as well, and future expectations are what primarily drive stock prices in fact. When things change, like the Fed raising interest rates, or even rumors that they will do so, this all gets accounted for in stock prices.

Right now, we are pricing in a “probably no action soon” view with the Fed and potential interest rate actions, although every word spoken and every belief altered affects this dynamic and its being accounted for in stock prices. Evidence of this perhaps not being as settled as we had thought therefore can influence these things.

Having a minority of committee members wanting to put rates up instead of just leaving them alone for now therefore may matter, as it may change the probabilities of this such that only a few on the other side may need to be swayed to change the overall consensus of the committee. However, this is nothing to really be that concerned about yet, as we know that what to do here isn’t completely obvious, and there is bound to be discussion and even some dissent.

We’ll know more during the next meeting, which is to happen on March 19-20, but in the meantime, nothing in the minutes of the last one should present any real reason for concern.

Andrew Liu

Editor, MarketReview.com

Andrew is passionate about anything related to finance, and provides readers with his keen insights into how the numbers add up and what they mean.

Contact Andrew: andrew@marketreview.com

Areas of interest: News & updates from the Consumer Financial Protection Bureau, Trading, Cryptocurrency, Portfolio Management & more.