The Federal Reserve has a tough job but made its life—and possibly yours—a bit easier on August 27th at the Kansas City Fed’s symposium1. The Fed, remember, is somehow supposed to help the U.S. economy balance high employment with price stability, while also being ready to step in and aid the economy in times of crisis. America has historically distrusted giving any central authority that much power. I’d argue that Fed has been effective at its job. Heck, I’m amazed the economy hasn’t tanked like the Titanic in the midst of the pandemic. I’m grateful.
That central role the Fed plays in managing economic growth makes any change in its targeted inflation and growth rate major news. And we got exactly that in Fed Chair Jerome Powell’s speech when he announced a fundamental shift in its monetary policy2.
In the past, the Fed has targeted a consistent two percent inflation rate, but will now seek to keep inflation hovering around two percent. That implies the Fed won’t necessarily leap to raise rates at the first hint of an economic recovery. As long as the Fed doesn’t perceive a risk of prolonged inflation, it will focus on maximizing employment, more specifically in addressing income inequality.
One of Jerome Powell’s predecessors, Ben Bernanke, sought to make the Federal Reserve more transparent to economic participants. Mr. Powell’s stance might reduce that transparency since he doesn’t mention what exactly that long run timeframe will be. But he did make a compelling argument for the shift, saying that in the Seventies and Eighties, inflation was the biggest concern but, because of our aging population and slowing productivity growth, now the bigger threat is falling prices.
Though falling prices might sound just ducky, consumers start to wait for even lower prices and companies have a tough time making a profit. That leads to layoffs, which would drive demand even lower. A vicious cycle takes over, one that the Fed would find difficult to reverse. The fear of falling prices is what kept the Fed targeting two percent inflation. That gave some room for being slightly below the target occasionally without prices declining across the board.
Maybe this doesn’t sound like a huge deal. But now investors don’t need to get as jumpy as before when growth picks up. The Fed won’t always be in such a rush to take the punchbowl away when the party gets starting. The implication here is that interest rates might remain low for quite some time. How long, we don’t know exactly. But now the Fed won’t always be acting as if the Great Inflation is always around the corner.
History does have more than a few examples of the Fed getting it wrong. Alan Greenspan couldn’t spot a bubble in a glass of Champagne. We won’t even discuss the Great Recession. Although Powell’s statement makes sense to me, we won’t know whether he was right for years. In the meantime, it implies the current low interest rate environment is closer to the norm than a response to a crisis. That can be good news for stock market and real estate returns.
1https://www.nytimes.com/2020/08/27/business/economy/federal-reserve-inflation-jerome-powell.html
Evan R. Guido is the Founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or eguido@aksalawealth.com. Read more of his insights at https://finance.heraldtribune.com/category/ask-guido/. Securities offered through Avantax Investment ServicesSM, Member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM, Insurance services offered through an Avantax affiliated insurance agency. 8225 Natures Way Suite 119, Lakewood Ranch, FL 34202. The views and opinions presented in this article are those of Evan R. Guido and not of Avantax Wealth ManagementSM or its subsidiaries. Past performance does not guarantee future results.