Emerging Markets / September 22, 2016

Federal Reserve Postpones Interest Rate Increase

The Federal Open Market Committee (FOMC) of the United States Federal Reserve met during the last two days to discuss economic and monetary policy. After weeks of public speculation, the FOMC decided not to raise the target for the federal funds rate from its current range of 0.25% to 0.5%. The target federal funds rate is the percentage range that ultimately decides the national interest rate for commercial banks loans and conventional savings accounts. This article looks at the data presented by the FOMC after its September meeting and analyzes the US investment market.

Federal Reserve Postpones Interest Rate Increase

In one of its most divided votes in recent years (3 in favor and 7 against), the FOMC decided against raising the target range for the federal funds rate to 0.5% to 0.75%. In spite of the positive signs presented by macroeconomic indicators, such as the employment rate, job creation, and GDP growth, the Federal Reserve decided to prolong the economic stimulus that is expected to come from consumer spending. However, it is arguable whether, after years of near zero interest rates, continuing this monetary policy will yield any further results. Nevertheless, there are several reasons why the FOMC might have decided to proceed as it did, one of which is to not prompt a major economic change weeks before a presidential election.

The fact remains that, since the 2008 financial crisis, investors and financiers have not been able to rely on traditional government securities or money market funds as tools that yield substantial returns. In fact, most of these instruments that are considered “safe” or “conservative” struggle to even make up for inflationary growth. In spite of the remarkably low inflation rate that the US has experienced over the last several years, well below the 2.0% target, these traditional financial instruments present yields that are even lower.

Therefore, it should come to no surprise that, since 2008, there has been a substantial migration of capital to private sector bonds, international stock markets, and complex financial instruments. In this regard, the US stock markets have grown dramatically over the last 7 years. For example, since 2009, the Dow Jones Industrial Average has gone from 7.000 points to more than 18.000 in 2016. Likewise, the S&P 500 has raised from approximately 700 points in 2009 to over 2.000 this year.

Looking Forward

If the macroeconomic indicators for the US continue to progress as expected, it is very likely that the FOMC will increase the federal funds rate before the end of 2016. However, it will likely take years for the money markets to become lucrative investment instruments once again. According to the personal consumption expenditures index projection published by the Federal Reserve this month, inflation is expected to normalize at its 2.0% target rate by the end of 2017. Meanwhile, it is highly unlikely that the interest rates on government bond yields will surpass 2.0% within the same timeframe. Therefore, in the short and medium term, investors will continue to rely on unconventional or non-government issued financial instruments to overcome inflation and achieve real growth within their respective portfolios.

(Read more about the July 2016 FOMC Meeting)

Latest Media