Though, for the most part, Minneapolis Fed President Narayana Kocherlakota didn’t find the new forward guidance issued by the FOMC justified, he did strongly endorse one key aspect of the report.
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What Kocherlakota endorsed
The FOMC guidance provides information about the committee’s intentions for the Fed funds rate once employment and inflation are near mandate-consistent levels. Those intentions are appropriate, and communicating them should help stimulate economic activity by reducing uncertainty about the likely path of the Fed funds rate once the committee reaches its goals.
Accordingly, the new forward guidance reads, “When the committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2%. The committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the committee views as normal in the longer run.”
The Fed funds rate
So, though the FOMC statement may not be clear in stating what would trigger a rise in the Fed funds rate, it does establish that even when employment and inflation conditions are consistently near mandate levels (which is where the uncertainty lies), the Fed may continue to keep the Fed funds rate low, depending on economic conditions. So investors might expect the Fed funds rate to maintain its zero bound figure, at least in the short term.
ETFs like the ProShares Short 20+ Year Treasury (TBF), the HOLDRS Merrill Lynch Pharmaceutical (PPH), and the Vanguard Information Tech ETF (VGT)—which has its major holdings in information technology companies like Apple Inc. (AAPL) and Google Inc. (GOOG)—could do well during the early part of tightening cycles, when the Fed starts raising the Fed funds rate.
The FOMC expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to gradually improve.
To find out more about fixed income securities and the Fed, see the Market Realist series Do last week’s economic releases support the Fed’s tapering stance?