Politics and Stock Volatility Turn Up The Heat on The Fed

Given the current environment, even no action in next week's FOMC meeting is likely to invite scrutiny. Understand what influences Fed policy and how it affects CDs, savings, credit cards and loans.
By Richard Barrington

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politics_and_stock_volatilityNext week's Fed meeting was supposed to be a relatively quiet one -- but recent events could put it squarely in the spotlight.

When the Federal Open Market Committee (FOMC) meets again on November 7th and 8th, the most likely outcome is that there will be no change in the Fed's interest rate target of 2.0 to 2.25 percent. That would fit the pattern of recent meetings, which has seen the Fed raise rates by a quarter point at every other meeting over the past year.

Even so, events more than predetermined patterns determine Fed policy, and recent events are raising questions about whether the Fed is on the right track.

Economic developments supporting FOMC policy

The Fed meeting will occur in the wake of recent data from the Bureau of Economic Analysis confirming that economic trends conducive to a rate increase remain on track:

  1. Gross domestic product
    While real growth in the GDP is estimated to have slipped from a 4.2 percent annual rate in the second quarter to 3.5 percent in the third, taken together these quarters constitute the strongest six-month period of U.S. economic growth since 2014.

  2. Personal consumption expenditures price index
    Meanwhile, the PCE price index (a measure of inflation the FOMC tends to emphasize more than the Consumer Price Index) has risen by 2.19 percent over the past year. This is slightly above the Fed's 2.0 percent target. Higher rates are one tactic used to stem the rise of inflation and, with the economy growing steadily, there would appear to be latitude for the Fed to raise rates without cutting short the economic recovery.

Besides having recent economic evidence in favor of raising rates over time, the Fed is also pursuing a goal of policy normalization, which in part entails restoring interest rates closer to historic levels. With the economic expansion now into its tenth year, the FOMC would like to raise rates in order to have more room to lower rates as a monetary stimulus once the next recession comes.

With all that being said, the Fed usually tries to take an incremental approach to adjusting rates so as not to disrupt the economy. That's why the FOMC may well skip raising rates at next week's meeting after raising them in its last meeting. Still, the course remains to push rates higher over time.

The stock market has other ideas

While the economic case for higher Fed rates is strong, the stock market seems to be having trouble coming to terms with the prospect of higher rates.

Stocks thrive when rates are low for a number of reasons. Therefore, recent stock market volatility has been attributed in part to the Fed's current direction toward higher rates.

The struggles seen in the stock market have prompted criticism of the Fed recently, but the fact that the market seems to be hitting a wall right before a hotly contested mid-term election may have made some of the criticism more strident. This heightened scrutiny means that, even if the Fed decides to do nothing next week, it won't be a quiet, under-the-radar kind of meeting.

A time-honored analogy for rate increases during a bull market is that no one likes to see the punch bowl taken away while the party is still going on -- but keeping rates too low for too long can fuel the kind of speculative bubble that has resulted in painful crashes in the past. Taking the punch bowl away now by raising rates may make the resultant hangover less painful.

Pre-FRB meeting rate advice: Translating this for consumers

Consumers feel the impact of higher rates in a variety of ways. Savers have seen some benefit from higher interest rates on CDs, savings and money market accounts; however, rates on deposit products have not risen uniformly across the board. Borrowers, on the other hand, may feel the effects of higher rates on credit cards, mortgages, and auto loans more immediately, making it harder to service their debt.

Even if the Fed continues its pattern of the past year and does not raise rates next week, the trend toward higher interest rates is here. Bankers and other financial professionals watch the same economic developments as the Fed and don't need to wait for the FOMC to act before they adjust to changing conditions. Most notably, unless inflation cools down, expect interest rates to continue to rise. This will be costly to borrowers; but it could cost savers as well if they don't adopt a more proactive approach to finding the highest savings account rates and CD rates just to keep up with inflation.

The Fed sometimes takes the heat for rate increases, even thought economic conditions are what really drive interest rates. With a stormy stock market environment and a key election the same week as the next FOMC meeting, don't be surprised if that heat intensifies even if the Fed takes no action in its upcoming meeting.

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Previous Federal Reserve Board Update Articles:

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1/31/20183 ways to profit when market rates outpace the Fed
3/21/2018Fed rate increases not helping consumers
5/2/2018Interest rates surge despite Fed's inaction
6/13/2018Your strategy when the federal funds rate rises
8/1/2018Banks aren't waiting for Fed rate increases
9/26/2018September 2018: Rate hike may hurt more than help consumers
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