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Is it fair to blame the Fed for the volatility in the market?

19 October 2018

Is it fair to blame the Fed for the volatility in the market?

Over the past few weeks, we have seen equity markets fall and volatility pick up. President Trump, never shy of pointing a finger, quickly pushed the blame on his central bankers who have been normalising interest rates. He labelled them 'loco' while branding their interest rate increases as ridiculous. So, is the Federal Reserve (Fed) just doing their job or does the president have a point?

It is important to remember that the President nominated the current Fed chair, Jerome Powell, back in November 2017. Powell was seen as the continuation candidate and given his predecessor's (Janet Yellen) dovish tilt, his nomination seemed to indicate a preference of low interest rates by the president. It is easy to see why a real estate developer would favour low borrowing costs, especially given his prior painful experience in Atlantic City. Central banks lower interest to stimulate the economy during periods of slower growth and subsequently raise interest rates as the economy picks up in order to encourage consumers to save more and spend less.

Taking a closer look at the US economy, there are several factors that support further increases in interest rates. Firstly, unemployment has reached a 49-year low in the US indicating a strong economy where wage pressures are increasing. Job openings rose to new record high of 7.14 million which equates to 1.15 jobs per unemployed person. The quits rate, which tracks employee driven job separations, stands at 2.4%, levels last seen 17 years ago. From a business perspective, survey indicators show confidence in future economic prospects across a broad array of participants. The Small Business Optimism Index reached a new all-time high in August, which tracks 800 small companies since 1974.  This broad based confidence, aided by the fiscal stimulus plans enacted at the end of last year, has spurred US growth above its long term trend levels.

Hence, it is prudent for the central bank to move interest rates gradually higher to avoid excessive consumption in the economy rather than having to respond more aggressively in the future. Whilst the president likes interest rates to remain low, his fiscal plans have increased the need for the Federal Reserve to raise interest rates to slow the economy gradually down to a sustainable pace. Whether they can achieve this without causing the next recession is questionable based on previous rate hike cycles, but interest rates at 2.0-2.25% for an economy that grew 4.2% annualized over the second quarter are still not what we would consider 'loco'.

 

 

 

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Is it fair to blame the Fed for the volatility in the market?