Interesting Thoughts on Fed Policy

One question on many investors’ minds these days is the future path of Fed policy and what that will mean for interest rates. Misconceptions surrounding Fed thinking and its current economic targets abound. Chris Low, the chief economist at FTN Financial, recently gave a presentation on this topic and we felt it would be good to pass along his thoughts. The first market misconception that Chris pointed out was that the 6.5% unemployment rate level is not a trigger to start raising rates. He believes that when we reach 6.5% unemployment, it will begin the debate within the Fed on when to adjust monetary policy. He also pointed out that the rate of change in the unemployment rate slows as we get closer to full employment, meaning that it could take much longer to reach the 6.5% level than what is currently expected in the markets (Fed Funds futures expect the Fed Funds rate to begin rising in mid-2015). Chris also pointed out that the Fed has been much more vague on its quantitative easing campaign, and that it is more important to watch what the committee does with quantitative easing and less what it says on the topic. He believes that the Fed can use the Fed Funds rate to manage the economy, and take its time to reduce its balance sheet. While the Fed’s portfolio of securities is large, it still has a very short duration. He also highlighted the fact that, since the Fed does not mark its portfolio of securities to market, it will not be forced to sell securities should interest rates rise. All-in, it is important to remember that there are many moving parts, and focusing only on one rate or statistic related to monetary policy could prove to be a mistake.