Last Wednesday was Janet Yellen’s first press conference as the Federal Reserve’s chairwoman. She commented on the “considerable period” language in the Fed’s monetary policy statement, which refers to the length of time between when the Fed will end Quantitative Easing and when it will start raising interest rates. In response to a question from the press, she said the term “considerable period” means rates might begin to rise six months or so after the Fed concludes its asset purchases. The stock market reacted immediately, selling off in afternoon trading.
In reality, it does not seem the news warranted a market sell-off, as any changes to the Fed’s previously communicated policy do not seem all that significant. Should the Fed continue on its current path of tapering its asset purchases by $10 billion following each meeting, its quantitative easing policy will stop following its meeting in either this October or December of this year. If it is the latter, then six months would take us to the June 2015 meeting. That is about the time the futures market had already priced in for the first rate hike.
The Fed’s targeted interest rates for 2015 and 2016 did increase slightly from 0.75% for 2015 and 1.75% for 2016 to 1.0% and 2.25%, respectively. However, there is considerable uncertainty involved in forecasting the level of the fed funds rate at a point in time more than two years away. The ultimate action is dependent on incoming economic data, particularly a continued labor market recovery. That uncertainty makes the impact of the increases less meaningful, at least from an academic perspective.
The Fed also added uncertainty as it is no longer revealing the specific indicators it is using or, perhaps more importantly, how it might react to any changes in those indicators. As a result, investors are left with little choice other than to incorporate the Fed’s explicit rate projections into their thinking. Unfortunately, the lack of clarity in its forward guidance increases the likelihood that the markets will focus even more on small changes in the Fed’s explicit rate projections.
Reaction to short-term events such as was seen after the FOMC meeting is what leads individuals to underperform the market averages over the long term. The primary reason for this outcome is that people let their emotions get in the way. This causes them to “buy high and sell low.”
The manner in which the Fed will tighten monetary policy and ultimately increase interest rates is uncertain. The actions it takes can have either a positive or negative market impact. That being said, from an investment perspective, we are not losing sleep worrying about what actions the Fed will ultimately take. Recent events do not cause us to alter our long-term expectations for the underlying business performance of the securities held in client accounts.