But if I knew how to manage my portfolio safer and smarter than most hedge fund managers, I could realistically grow my wealth.
The Fed funds rate
As we mentioned in the previous part of this series, the Fed funds rate has remained in the range of 0% to 0.25% since December 2008. At this month’s FOMC meeting, the 16 members of the FOMC provided individual forecasts on when they expected the Fed funds rate to rise and by how many basis points (or bps). Fourteen of the 16 FOMC members estimated a rate hike by 2015. Fed officials also revised their forecast for the median rate at the end of 2015 to 1% from 0.75%. Predictably, markets tanked on the news.
How did markets react to the revised forecast?
Markets were caught unaware of the Fed’s rate hike estimates, as they expected a rate rise to come much later and also because the Fed had raised its median forecast by 25 bps by 2015. Other things remaining constant, an increase in the Fed funds rate would make borrowing much more expensive for companies and also lower bond prices, impacting both stock and fixed income markets.
Both stock and fixed income prices were down following the Fed’s announcement. The State Street SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index, was down 0.5% on March 19. SPY components Proctor & Gamble (PG) and Johnson & Johnson (JNJ) fell about double the index and were down 1.24% and ~1%, respectively. Popular fixed income ETFs like the iShares 20+ Year Treasury Bond ETF (TLT) and the Vanguard Total Bond Market ETF (BND) were down 0.8% and 0.5%, respectively, following the Fed’s announcement.
Richard Fisher’s take on the revised rate guidance
Only five presidents of the 12 Federal Reserve banks form part of the FOMC each year, and they’re elected by rotation. According to Richard Fisher, Dallas Fed President, as the composition of the FOMC changes each year, so does the voting structure and therefore the estimates provided.
This year, the 25 basis point (or bps) increase by year end 2015 and for 2016 and longer by 50 bps “was read as a massive shift in the expectations of the committee.” Fisher said those numbers were the FOMC’s best guesses, based on economic models, saying that markets had a fetish or fixation on the Fed’s “dots.” He said, “Those forecasts are for year-end 2015, which gives us a lot of space between now and YE 2015 for a 25 bps move in the Fed funds rate.”
On the qualitative versus quantitative debate for the Fed funds rate
“This effort to be more transparent complicates the business of qualitative forward guidance. The reality is you cannot quantify with specificity what’s likely to happen few years hence,” said Fisher. He said that while central banks will try and provide as much detail as possible, “You cannot expect specific quantitative guidance, without mistakes being made, and then our reputations are being put at risk because we couldn’t live up to the forecasts we made because conditions had changed.”
To find out what Richard Fisher had to say about the impact of quantitative easing and the low Fed funds rate on corporate investment, read on to Part 4 of this series.
© 2013 Market Realist, Inc.