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It is a difficult to decipher whether the Federal Reserve’s March 20 decision to not raise interest rates this year is good for financial markets. Maintaining rates could ensure that credit continues to surge and the 10-year bull market continues its upswing, which would be a boon for traders and investors.
On the other hand, keeping rates at the same level raises questions about the country’s true economic health. If the government maintains artificially low interest rates, while providing consumers with extra money to spend, this could mean inflation is on the horizon.
Fed research also shows well-established companies benefit from low rates. On the other hand, low rates make it harder for entrepreneurs and startups to do business. Established companies can buy high-tech rivals in a low-rate environment, which makes it difficult for startups to launch.
As the CEO and founder of a company that has been dealing in commodities for 10 years, with offices worldwide, I have a unique perspective on the global events that impact the world economy. A major problem with Fed rate increases or reductions is — when dealing with inflation — the Fed doesn’t always take the same point of view as the passive investor. The Fed appears to have its own version of inflation, excluding things like the price of gas and food that consumers purchase daily.
The key to deciding if the Fed’s decision is good for the markets is focusing on actual inflation, inflation expectations and wage growth to determine if the economy is running above or below potential, as Minneapolis Federal Reserve Bank President Neel Kashkari highlights.
So, professional traders, sharp-eyed investors and well-established companies gain, but what about the passive investor whose funds are tied up, or the startup founder who can’t get off the ground? Let’s begin by what exactly the Fed is and who controls its reins.
A Brief History Of The Fed
Before the Fed, the U.S. economy faced recurrent incidences of panic, bank failures and financial crises. It as established to answer the nation’s need for a more stable financial system.
First and foremost — and something many don’t realize — the Fed is not a government agency, so its independence is supposedly safeguarded from political influence. It was set up to be free from expectations, which would have been impossible if its leaders feared elected officials.
Congress established the Federal Reserve System to serve as the U.S. central bank. To carry out the daily operations of the system — and to avoid the richer areas from monopolizing — the nation was divided into twelve Federal Reserve districts.
A critical factor is the Fed does not receive its funding from Congress; its funds come from investments and the interest it receives from U.S. Treasury notes it acquired as part of open market operations. These serve as major tools the Fed uses to raise or lower interest rates.
The thorniest problem for the Fed is figuring out the future path of inflation.
The Winding Path Of Inflation
Today, unemployment is at its lowest rate since the late 1960s and we are seeing the fastest increase in wages in a decade; however, the rate of inflation fell slightly in the second half of 2018. That isn’t supposed to happen when the labor market is what economists describe as “tight.”
So, what are the main problems with the Fed controlling monetary policy and the markets?
Some say the Fed is indirectly responsible for most of the stock market’s biggest crashes. Alan Greenspan, who in the 1990s was considered the Fed guru, called stock prices “irrational exuberance” but did nothing to stop them from rising. Then the dot-com bubble burst, and many people and companies were wiped out.
When 9/11 hit, the Fed jumped in to save the tanking stock market, brought interest rates back down to zero and created a climate that allowed the banks and their quantitative analysts to come up with mortgage-backed securities, credit default swaps and the securitized mortgage market.
As outlined in a recent Forbes article, the Federal Reserve believed it could use interest rates to stimulate the economy. By making borrowing easier, growth would follow. It tried this after the housing market bust, dropping short-term rates to effectively zero.
It didn’t happen as quickly as the Fed desired, so it added quantitative easing (QE) to the mix in 2008. QE stimulates the economy by making it easier for businesses to borrow money. However, more than a decade after QE was introduced, the economy is still not growing at the pace of past recoveries.
Implications For Investors And Entrepreneurs
Algorithmic trading is a strategy that relies on complex mathematical formulas and high-speed computer programs. It is estimated that some 60-70% of all trading is done by high-speed algorithms that work off the news — like Fed news and announcements. This was obviously not predicted when the Fed was conceived.
As mentioned above, startups and other entrepreneurs do not do well in a low-rate realm. Low interest rates can lead to big companies buying up ideas, according to a new study from researchers at the Federal Reserve Bank of Philadelphia. Satyajit Chatterjee and Burcu Eyigungor further highlight that the U.S. startup rate has significantly fallen since the 1990s, and “the driving force is the decline in the risk-free interest rate over the same period.”
As an entrepreneur and business owner, I predict that inflation will eventually hurt our businesses and growth. If the dollar is expanded too rapidly, it could become difficult for businesses and startup companies to grow. I hope this is not the case, but we will find out in the years ahead.
So, can we conclude that the Fed is a friend or foe of the financial markets? The answer: It depends. I believe it remains to be seen if entrepreneurs and startups will thrive in today’s economy controlled by the Fed.
June 13, 2019 at 07:33AM
Forbes – Entrepreneurs