The Federal Reserve finds itself torn between responding to volatility in the stock market and acting on positive economic data in its decision whether or not to raise interest rates. It is something of a test of wills, and at its latest meeting in January, the Fed postponed the test.
The Fed decided to stand firm with the interest rate policy set in mid-December 2015. Thus, it is neither moving forward with what is expected to be a series of upward interest rate moves, nor capitulating to a temperamental stock market with a surprise rate cut.
The good vs. bad news in the Fed's January statement
In its Jan. 27 statement, the Fed described a good news/bad news scenario for the U.S. economy. On the good news side: There is continued improvement in the job market, increased fixed investment by businesses and growth in household spending. On the negative side: Inflation remains well below normal, exports have been sluggish and inventory investments have been light.
Given this mixed bag, the Fed decided to keep the federal funds rate within the range of 0.25 to 0.50 percent set in December. It also cautions that this rate is likely to remain below normal levels for a long time. This amounts to continuing a monetary policy that may stimulate the economy despite the fact that the economy is several years into a recovery. While not in robust health, the economy is hardly on its deathbed either.
There are some costs to this caution. Keeping bank rates low limits monetary policy options should the economy slip into another recession, and also robs income investors of anything approaching a normal return.
Fed exercises caution after stock market volatility
One explanation for the Fed's abundance of caution might be the tempestuous start to the year for the U.S. stock market. As the Fed convened, stocks were down some 7 percent since the end of 2015. Though the Fed has made it clear that it expects to make a series of rate hikes over time, another step in that series now might have thrown the stock market into new hysterics.
Stock investors have become addicted to low interest rates. There was even some speculation in recent days about a new round of quantitative easing (a monetary policy that results in increased money supply and low interest rates) being in the offing, despite the fact that the job and housing markets continue to recover nicely. While the Fed did not indulge the market with any such new economic stimulus, it may also have been unnerved enough by recent volatility to postpone its next rate hike.
What the delay in a further Fed hike means for bank rates
The Fed's language continues to prepare the way for future rate increases, but it is also signaling that these will occur very slowly. If you are wondering what that means for bank rates, don't expect a very rapid response. Savings accounts did not rise following the Fed's December rate hike. The Fed's cautionary language suggests it may be a while before it pushes the federal funds rate high enough to force savings account rates higher. In short, rates may be headed upward eventually. But, meanwhile it still may be worthwhile to look into certificates of deposits and make a longer-term commitment to capture higher CD rates.
Comment: Do you think the Fed made the right decision in January to not raise bank rates even higher?
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