Fed’s July FOMC minutes have implications for stocks and bonds

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The U.S. Federal Reserve releases minutes for the July FOMC meeting

The Fed holds Federal Open Market Committee (or FOMC) meetings eight times a year. The 12-member FOMC is the Fed’s main policy setting body.

After each FOMC, the Fed issues a summary statement. About two or three weeks later, the Fed releases a more detailed statement. The statement is called the FOMC minutes. On August 20, the Fed released the minutes for its July FOMC held on July 29–30.

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Market participants are interested in the minutes. The minutes are particularly relevant for bond investors. The important decision to increase or decrease the federal funds rate is made at the FOMC. Changes in the federal funds rate translate across other fixed income investments. Bond prices rise when yields fall and vice-versa. The minutes also provide guidance on the economy’s future course.

Part 1

The Fed may be close to a change

Due to the Great Recession, the Fed kept the federal funds rate low at near zero levels. The Fed also embarked on three rounds of quantitative easing (or QE) by purchasing securities in the open market. QE caused the Fed’s balance sheet to bloat to over $4 trillion—an unprecedented level. Low rates and market liquidity would stimulate business investment. Business investment creates jobs.

The Fed’s July FOMC minutes contained detailed discussions about the improving economic outlook. This may bring forward monetary policy normalization. Normalization implies raising the federal funds rate and scaling down the size of the Fed’s bloated balance sheet.

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However, the FOMC participants had different views on the path for normalization. You’ll read more about normalization in the next parts in the series. This series will also cover the Fed’s view on the economic outlook. You’ll also read about why the Philadelphia Fed Chief, Dr. Plosser, disagreed with the FOMC statement.

Investor impact

An improving economic outlook can be bullish for stocks. The S&P 500 Index increased by 0.25% following the release of the Fed’s minutes.

Popular exchange-traded funds (or ETFs) that track stock market indices include the State Street SPDR S&P 500 ETF (SPY), the SPDR Dow Jones Industrial Average ETF (DIA), and the PowerShares QQQ (QQQ). They track the S&P 500 Index, Dow Jones Industrial Average, and the NASDAQ-100, respectively.

However, bond yields tend to rise during an upswing. Treasury yields increased following the release of the minutes. An increase in yields implies lower bond prices. This affects ETFs like the iShares 20+ Year Treasury Bond ETF (TLT). However, inverse ETFs like the ProShares UltraShort 20+ Year Treasury (TBT) benefit from rising yields.

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