Fed acts, Investors yawn

David MoonBlog

There was a time that investors were so focused on possible Federal Reserve Board interest rate increases that the media used paparazzi tactics to capture a glimpse of the briefcase of then-Chairman Alan Greenspan, convinced that a thicker attaché telegraphed a likely rate hike. Times have certainly changed. In the late 1990s Alan Greenspan was a rock star. Who can even name today’s Fed Chair?

When the Federal Reserve Board increased the federal funds rate two weeks ago, stock investors seemed disinterested. Bond investors seemed outright contrary, as the rate on the 10-year Treasury note actually declined. The Fed does not control market rates. The only interest rate over which the Fed has decree control is the Fed Funds rate – that is the rate at which banks loan money to each other overnight. The Federal Reserve Board does not set rates on mortgages, CDs, municipal bonds, or automobile loans. The volume of overnight lending between banks has fallen by 50% in just the past two years, as banks continue to sit on near-record liquidity and excess reserves. This renders the Fed Funds rate increase almost completely symbolic.

A monetarily impotent Fed does not mean that interest rates do not matter. They do. Interest is the price of money, influencing the cost of capital for businesses and investors. When investors are faced with higher costs of capital, they require higher rates of return. But in the current environment, market rates – significantly determined by the supply and demand for bonds and CDs – are much more influential than the Fed.

Not only is the federal funds rate mostly meaningless, investors weren’t surprised by the Fed’s hike in the rate. The market swings wildly in reaction to surprises. This rate increase was no surprise. Neither will additional increases this year be a surprise. The Fed has already announced its intention for two additional rate hikes in 2018.

If done as orderly and expectedly as the most recent hike, the two additional 2018 rate increases will almost certainly be met with similar investor disinterest. However, a sudden, unexpected rate increase – especially in long-term Treasuries – would not sit well with either stock or bond investors. Another possible negative surprise would be if the Federal Reserve does not follow through with these two additional rate increases. The Fed cannot create economic progress; it can only temporarily stimulate or dampen activity. The stated reason for these Fed rate hikes is to prevent a strong economy from becoming so overheated that excess inflation results. If the Fed chooses not to follow through with the announced future rate increases, it would be a signal that the economy has unexpectedly slowed. A slowing economy would concern investors more than symbolic rate increases.

David Moon is president of Moon Capital Management. A version of this piece originally appeared in the USA TODAY NETWORK.