Neutral | September 28, 2018

Last week, the Federal Reserve Board (FRB) increased the short-term rate by .25% making FRB policy technically neutral for the first time since 2008!


Since the financial crisis, the FRB has been very accommodative… First with quantitative easing 1, 2, and 3 (where the FRB purchased Treasuries to infuse cash into our economy). Second by retaining a great deal on their balance sheet as to avoid creating a liquidity crisis. Even over the last 3 years where the FRB has increased rates 8 times and gradually reduced its balance sheet, this was still viewed as accommodative as rates have remained so low.


Core personal consumer expenditures (inflation) for August came in at a solid 2%, coincidentally the FRB’s target. This means that inflation is currently not running too hot where the FRB needs to dramatically increase rates to slow the pace of inflation.  Nor is it too soft where the FRB needs to have a lower rate policy in order to stimulate consumption.


With the FRB short-term rate at 2.00% to 2.25%, FRB policy is at par to inflation. That is neutral. The next FRB rate hike (expected in December) signals ‘tightening’. This means we should be seeing strong employment growth, strong consumption, and strong GDP… all things that would point to higher inflation down the road.

The overall importance to the current FRB hike cycle is that they had gotten all the way to zero during the last recession. These moves are necessary to rebuild the tools it needs to fight the next recession. So, while accommodative FRB policy generally means strong equity returns, it also means an economy that is likely to go off the rails with little recourse for repair!


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