The most important news for investors last week was the commentary from the US Federal Reserve on its future monetary policy. Readers might remember the events of 2013, when previous Chairman of the Fed, Ben Bernanke, triggered the ‘taper tantrum’, a spike in market volatility caused by the Fed announcing its intention to wind down the quantitative easing (QE) programme. Markets fell because there was a gap between market expectations and what the US Fed announced. The Fed has learned its lesson from 2013 and doesn’t want to repeat that mistake this time around.
The plan now is to avoid negative market reaction to Fed announcements by clearly guiding market expectations. The current Fed Chairman, Jerome Powell, last week announced that the Fed will maintain a policy to let US inflation rise above the 2% target to help keep the economy from being trapped in low growth. Short term deviations from the average 2% will be tolerated (basically, the Fed won’t raise rates even if inflation goes above 2%).
For the time being, this appears to be a pragmatic solution to manage market expectations. The market can expect lower rates for longer. Lower rates for longer means two main things for investors: (i) it supports higher equity market valuations, and (ii) it is potentially negative for bond prices.
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