As I write this, Janet Yellen, the U.S. Chair of the Board of Governors of the Federal Reserve is making a presentation to the Senate Banking Committee.
Yellen began her time as head of the Fed in January 2014 taking over the reins from Ben Bernanke.
Bernanke resided over arguably one of the most difficult times in the American economy. He was in charge in 2008-2009 when the real estate bubble burst and threatened to severely damage our monetary system.
Bernanke, who led for eight years, from 2006-2014, used unprecedented measures to prevent another Great Depression.
Starting in November 2008, the Fed, led by Bernanke, began buying bank debt, mortgage backed securities and Treasury Notes. This was called Quantitative Easing (QE) and it was a key way to stimulate the economy when standard measures (lowering interest rates) were not enough.
All available data shows that QE and low interest rates have combined to contribute to a much stronger economy, stock market and improved employment numbers. The U.S. stock market bottomed out in March 2009. The Dow Jones Industrial Average (DJIA) recently surpassed 18,000. Unemployment dropped from a high of 10 percent in October 2009 to the current rate of 5.7 percent.
When Yellen took over in January of last year, QE3 was in full swing. The issue for our current Fed boss is how best to unwind the various stimuli that Bernanke put in place. Yellen is no stranger to these policies — she was the Vice Chair of the Fed from 2010 to 2014. Her difficult job is to tighten policies at just the right time and in such away so as to not derail economic recovery. She has already deftly slowed then stopped QE, ending that measure in October 2014.
The buying of assets may have stopped but the Fed made the decision to hold the bonds through maturity. The total assets on its balance sheet? $4.5 trillion.
The next step in normalizing our monetary policy is to raise interest rates. We are currently one of the only nations that can consider this step. In fact, Europe just started its own Quantitative Easing in January 2015 to help spur economies there. The Fed has not done a rate hike since 2006 and many are keeping a close eye on ‘Fed Speak’ to see when the first move may arrive.
The consensus is a rate increase in June 2015. The key word in the Fed statements is ‘patient.’ The translation for ‘patient’ is that there are still at least three meetings until the Fed raises rates. In her testimony, Chairwoman Yellen insinuated that ‘patient’ would be dropped in March but it would not necessarily mean a rate increase in June.
Has Fed testimony always been such a spectator sport? Yes, but the depth of transparency in policy under Yellen and Bernanke is a new feature. I recall during Alan Greenspan’s reign (preceding Bernanke), which ran over five terms from 1987 through 2006, CNBC using his “briefcase indicator” to determine if rate changes were coming. The theory held that if Alan Greenspan’s briefcase was light, rates were to remain steady. If his briefcase appeared heavy, it meant he had to bring documentation and evidence to support the change. The commentators on CNBC used a telestrator to circle then-Chairman Greenspan’s briefcase while he walked into the Fed meeting.
Why the concern over the Fed and interest rates? Interest rates affect mortgage rates, interest rates on savings accounts and bond rates. Thus, an increase will make mortgages more expensive, saving more attractive and borrowing for companies, governments and municipalities more expensive.
What are the key indicators that the Fed is looking at in making its decision? The Fed stated its unemployment goal is 5 percent. We are very close to that measure with the latest figure being 5.7 percent. In addition, the Fed wants a ‘normal’ inflation rate, which is described as 2 percent. The current rate is 0.8 percent. With the amount of stimulus over the last five years, rampant inflation was expected. However, with the dive in oil prices, Greece/Europe issues and the general decrease in other commodities, inflation is tame and even deflation is feared. Thus, the Fed is walking a tightrope of keeping the economy not too hot and not too cold (the fabled “Goldilocks” economy).
The overall opinion is that the first Fed rate increase since 2006 will come this year. This is a very positive step as it means the economy is strong and expected to continue to grow. It will create changes in the bond markets. Current bonds could get hit because of rising interest rates and utility stocks typically get hit in a rising interest rate environment.
When exactly will that rate increase occur? That’s something that not even the Federal Reserve knows yet.
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