On August 27, Federal Reserve Chairman Jerome Powell dramatically changed monetary policy that had been in place since the 1970s. He did so in a speech at an economic symposium sponsored by the Federal Reserve Bank of Kansas City in Jackson Hole, Wyoming. The speech was entitled “Navigating the Decade Ahead: Implications for Monetary Policy.”
Within the speech, given the current economic environment, Powell challenged the veracity of the Phillips Curve. This is an equation which addresses the inverse relationship that once existed between interest rates and employment. Traditionally, as employment declines interest rates rise — and vice versa. This has been the bedrock of Fed monetary policy for more than 40-years.
In fact, in 1977 Congress amended the Federal Reserve Act of the 1920s, directing the central bank to “promote effectively the goals of maximum employment, stable prices, and moderate long term interest rates.” This is commonly known as the Fed’s Dual Mandate.
But Powell has turned that belief on its head. He stated that “by the early 2000s, many central banks around the world had adopted a monetary policy framework known as inflation targeting. Although the precise features of inflation targeting differed from country to country, the core framework always articulated an inflation goal as a primary objective of monetary policy.”
Beginning in 2012 the Fed began to internally challenge this mandate as, over time, it became evident that the relationship between interest rates and employment was becoming less direct as global GDP growth projections slowed, interest rates fell. And although unemployment in the United States eventually declined to 50-year lows, it did so without any sustainable inflation that was at or near the Fed’s target of 2%, real (after inflation).
Historically, once inflation hit 2%, the Fed would hike rates.
However, ever since the Great Recession of 2008-09 inflation has seldom run anywhere near the 2% target. This presents cause for concern for the Fed as “inflation that is persistently too low can pose serious risks to the economy.”
So Powell and the Fed have changed course, moving away from the 2% inflation targeting set back in 1977 to one in which “will seek to achiever inflation that averages 2% over time. Therefore, following periods when inflation has been running below 2%, appropriate monetary policy will likely aim to achiever inflation moderately above 2% for some time.” Translation – easier monetary policy for longer; lower interest rates for longer.
Fast-forward to the two-day meeting of the Open Market Committee of the Federal Reserve (FOMC), the body that determines monetary policy, that concluded this past Wednesday. The FOMC released not only a statement that suggests lower for longer, but also supporting data that projected their 2% inflationary target would not be reached until at 2023. Within his post-meeting press conference Powell stated that “with inflation running persistently below this longer run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent.”
This in turn will keep the fed on the sidelines when it comes to raising interest rates. This is good news for equity investors.
Given this policy shift, along with strides the health care industry is making to find a vaccine to combat the COVID-19 pandemic, we believe any market correction of over 10% is a buying opportunity.
We expect the markets to remain volatile as the election approaches. However, we also believe they will be higher at the end of 2020 than their current levels.
Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call (518) 279-1044.
