This past Thursday (9/17/15), the Federal Reserve announced that they were leaving their short-term interest rate-the Fed Funds rate-unchanged. One of the reasons cited was that they wanted to ensure that international developments and recent market volatility do not cause the U.S. economy to slow.
The risk in this decision is that businessess may lose focus on their core business as they fixate on what the Federal Reserve is going to do. We saw evidence during the congressional battle over the budget in 2010 and 2011-does anyone remember the “Fiscal Cliff”?-that many businesses chose to sit tight and do nothing until the uncertainty was clarified. During that time, the sentiment from many businesses was “interest rates are going nowhere so I might as well wait to see what happens with Congress”. Now we appear to be entering another period of potential Congressional battles over the budget and the Federal Reserve just told us that interest rates are going nowhere for now. Sound familiar?
The other risk is that continued market volatility could cause businesses to be cautious as they wait to see if this is simply a period of volatility or if it is the start of a bigger problem. If the Federal Reserve was hoping that their decision to do nothing would reduce market volatility, they are not being rewarded yet as fixed income yields have declined and equity markets have performed poorly since the announcement.
Whether the Federal Reserve should have voiced confidence in the economy by starting the process of raising rates remains to be seen. What is becoming clear is that when the Federal Reserve postpones raising rates, the investment markets are interpreting that as a sign that the Federal Reserve must be more worried about the economy than they have publicly stated.
The Federal Reserve now faces the challenge of communicating and convincing businesses and investors to carry on with their normal course of business and not become fixated on the Fed.
Steve Scranton is the Chief Investment Officer and Economist for Washington Trust Bank and is a CFA charter holder with over 30 years of investment experience with equities, tax-exempt and taxable fixed income securities. Steve actively participates on committees within the bank to help design strategies and policies related to client and bank owned investments. Steve also serves as the economist for the Bank and has been a featured speaker for both client and professional organization events throughout the Northwest.