No need to fret about interest rates when you can just listen to the Fed

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Following a brief respite from obsessing about tariffs and potential trade wars, market participants are back to a virtually single-minded focus on Federal Reserve policy and interest rates. The ultimate irony is that the large majority of investors and politicians do not understand the institution and the limitations of its powers, yet complain about Fed actions and inactions.

The central bank’s mandate, as defined by Congress in the Federal Reserve Reform Act of 1977, is to “maintain maximum employment, stable prices, and moderate long-term interest rates.” It attempts to achieve that mandate through monetary policy actions. An opaque institution to most, the Fed has been very transparent in signaling future monetary policy actions, has followed through with those actions, and has explained developments after the fact. The Fed has done a masterful job of helping guide the economy out of the abyss of the financial crisis yet is continually second guessed by politicians and pundits.

{mosads}Most investors understand that, historically, stocks perform worse in a rising rate environment than in a falling rate environment. Iconic investor Warren Buffett has described interest rates as working like gravity on stock prices: All other things being equal, the higher interest rates go, the less the future profits of businesses are worth in the present. While understanding the relationship between stocks and interest rates, many investors waste time and effort attempting to forecast future Fed actions. The simple fact is that all you need to do is to listen to the Fed.

In perhaps the least surprising development in recent memory, the Fed just raised its benchmark federal funds rate by a quarter-percentage point to a range between 1.5 percent and 1.75 percent. Fed officials also announced that they expected to raise rates another two or three times this calendar year, and three times next year. Last week, Federal Reserve Bank of Philadelphia President Patrick Harker confirmed that he expects that the central bank will need to raise short-term interest rates a total of three more times this calendar year.

Now newly appointed Fed Chairman Jerome Powell and the Federal Reserve Board of Governors face a much more uncertain political environment than their predecessors. The unpredictability of President Trump with respect to both fiscal and foreign policy make the formulation of the appropriate monetary policy much more difficult and could lead to changes in course.

As a seasoned Fed watcher, I find it ironic that investors seemingly waste a lot of time trying to predict future Fed actions. By the end of 2019, I would expect the benchmark federal funds rate to be between 3 percent and 3.25 percent. Renowned poet and Presidential Medal of Freedom award recipient Maya Angelou once gave advice for the business of living that applies equally well to the Fed and the business of business: “When someone shows you who they are, believe them the first time.”

Robert R. Johnson, PhD, CFA, is president and chief executive officer of the American College of Financial Services. He is co-author of “Strategic Value Investing,” “Invest with the Fed” and “Investment Banking for Dummies.”

Tags Donald Trump economy Federal Reserve Finance Jerome Powell Stock market

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