As the economic recovery gathers steam and vaccine distribution accelerates, many investors are concerned about how the Federal Reserve may react. If inflation and long-term interest rates continue to rise, will the Fed keep policy rates at zero and allow the economy to overheat? Or will they be forced to raise rates and end the party sooner than expected? What does history tell us about Fed policy and how could it affect investors?
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A rate increase seems unlikely in 2021
In a way, history is repeating itself as worries about the Fed take center stage, just as they so often do during recoveries. The irony is that, during the mid-2010s after the global financial crisis, investors were worried about a Fed “liftoff” – i.e., the start of federal funds rate hikes. Today, investors are more concerned that the economy may overheat and spark runaway inflation if the Fed doesn’t raise rates. All of these concerns are taking shape even as the COVID-19 crisis continues, a factor that is well outside of the Fed’s control.
At the moment, the Fed has made it clear that they don’t intend to increase the federal funds rate until at least 2023. This is partly because many parts of the economy may take longer to recover from the pandemic. For instance, the fact that some individuals have given up on seeking work and others have been misclassified by official surveys suggest that “true” unemployment is still much higher than average.
Chart: The federal funds rate has been held at zero since the pandemic began. Economic projections by Fed officials suggest that they don’t intend to raise rates until at least 2023
An equally important consideration for the Fed is that inflation has been much lower than expected since at least 2008. Whether this is due to trends in technology and globalization is the subject of academic debate. Regardless of the causes, the Fed’s position is that it will tolerate overheating inflation since it has run so cool for so long.
What does this mean for investors?
- Inflation has been declining for decades. And while there are re-flationary pressures as the economy bounces back from the pandemic, this is a far cry from the double-digit inflation rates experienced during the 1970s. Investors should consider what higher inflation means to their investment mixes and personal income statements without overreacting.
- Investors often fear the onset of Fed rate hikes even though history suggests that they are a natural and inevitable part of the business cycle. In general, the normalization of the Fed’s balance sheet and rate hikes from 2013 to 2019 occurred alongside a strong bull market.
Don’t be distracted by speculation
How quickly inflation will pick up and how the Fed will react are still the subject of speculation. What’s certain is that focusing too much on Fed decisions distracts investors from what truly matters: sticking to their long-term asset allocations and achieving financial goals.
Stay the course with a solid plan
As a long-term investor, one of your most important jobs is to make sure your investment mix carefully balances the need to manage risk with the need for potential gains. Market ups and downs and overheated media speculation can make even experienced investors nervous. It’s a good idea to stay the course with a long-term plan. By setting your investing on auto-pilot with autoinvest, you put dollar cost averaging and compounding to work for your bottom line — which can help you keep building through market ups and down. MoneyLion offers personalized portfolios that can help to keep you on track.
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