Federal Funds Rate Unchanged: What Does It Mean for Investors?

Well, there you go. The Federal funds rate didn’t waver from 0.25% in September. Instead, the can got kicked down the road, most likely until December. The FOMC’s voting members are mostly calling for a federal funds rate of 0.5% then.

Fed Funds Rate Unchanged. What Does It Mean for Investors?

Source: GrabPress

And just for the record, the decision to leave interest rates unchanged wasn’t a “just barely” affair. The Federal Open Market Committee voted 9-to-1 in favor of leaving the federal funds rate alone.

The $64,000 question investors are asking not-so-rhetorically is … now what?

Interest Rates Unchanged

As has become the case in recent years, any interest rate changes (or lack thereof) take something of a backseat to the language the Federal Reserve’s statement uses to accompany and justify the FOMC’s decisions. Thursday’s was no different. The briefing explicitly noted:

“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term. … The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring developments abroad.”

In other words, Janet Yellen and her cohorts understand what’s going on with China, and perhaps to a lesser degree, sees the stumbling blocks that Brazil, Russia and a handful of other nations have found of late.

While concerning, the FOMC has yet to be convinced those overseas illnesses will be infectious.

The Fed statement went on to say:

“Inflation has continued to run below the Committee’s longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation moved lower; survey-based measures of longer-term inflation expectations have remained stable. … Inflation is anticipated to remain near its recent low level in the near term but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of declines in energy and import prices dissipate.”

As a refresher, the annualized inflation rate including uber-low energy prices now stands at just a hair under 0.2%. Even taking cheap gasoline prices out of the equation, however, the annualized inflation rate remains at a palatable 1.8%.

Although the Federal Reserve’s decision to leave interest rates unchanged this month while loosely planning one for December came as no real surprise, it is interesting that the same voting members dialed back their long-term outlooks for the federal funds rate. For perspective, the 2018 Fed Funds expectation now averages 3.4%, versus an average estimate of about 3.8% after July’s meeting (when that outlook was simply classified as a “long term” outlook)

What the Federal Funds Rate Has Really Become

Stocks were all over the map following the news, pushed higher as well as lower as traders tried to rectify the decision with the Fed’s comments, deciding if this was a bullish or a bearish situation. The general consensus was, it was a decision ultimately bullish for stocks even though the stock market ended the day on the fence.

And why not? Cheap money is good for stocks, right? Surely there’s no downside of keeping interest rates at multiyear lows for years on end, is there?

They’re rhetorical questions, of course. And though a thinking man’s answers from a few years ago would have wisely pointed out there’s never an economic action without an economic reaction (for better or worse), in the real world today, there are enough investors now who believe super-cheap borrowing costs are so great for stocks that they’re able to create a bullish self-fulfilling prophecy.

Here’s a harsh reality: Investors have been spoiled by a long era of too-low interest rates, so much so the masses think they’re the norm. Indeed, one could argue the tail wags the dog now.

That is to say, Janet Yellen and the FOMC arguably didn’t postpone a rate hike so much because they felt it was the right thing to do. They postponed it most plausibly because they were terrified the stock market would outright revolt by pulling stocks sharply lower.

The irony is, keeping interest rates at these low levels is a decided sign that Yellen doesn’t think the economy is in fantastic shape (despite the encouraging Fed statement), while a rate hike would actually affirm the economy was on solid footing — a situation that’s truly good for stocks.

Or from a different perspective, if the economy can’t digest the difference between a federal funds rate of 0.25% and 0.5%, then we’ve got much bigger problems than which super-low interest rate to use. As was noted, though, the federal funds rate is no longer an economic throttle. It’s an instrument of behavioral finance, or psychology.

Whatever the case, the Fed was mostly dovish today, saying all the words investors wanted to hear, and not lifting interest rates. Let’s see how long it takes these investors to realize they may not always want what they ask for. Once inflation does kick back into high gear — and it’s coming — the Fed may have to become far more aggressive with rate hikes than most are expecting.

Then again, just like the Fed, investors are perfectly willing to kick that can down the road.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

More From InvestorPlace


Article printed from InvestorPlace Media, https://investorplace.com/2015/09/federal-funds-rate-unchanged-interest-rates/.

©2022 InvestorPlace Media, LLC