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Most of the investing world is a bit weird about the Federal Open Market Committee meetings, which is where the nation’s central bank announces its latest interest rate policy. The idea is that if the Fed raises or lowers this rate, then interest rates throughout the economy will bounce up or down accordingly, raising or lowering the cost of financing for America’s corporations and potentially leading to recession (and lower stock prices) or economic prosperity (and higher stock prices).
If you follow this school of thought, then the FOMC news on December 13 was good: the committee economists and bankers voted unanimously to keep the benchmark overnight borrowing rate somewhere between 5.25% and 5.5%. They also projected that there would be three rate cuts in the coming year, assumed to be 0.25% each.
The Fed has initiated 11 rate hikes in the last two and a half years, taking the fed funds rate to its highest level in more than two decades. You might think that this was a sure recipe for economic disaster. But in fact, the most recent economic reports have shown extraordinary growth in the U.S. economy.
Do changes in the Fed Funds rate have a direct impact on interest rates? A recent study by the Federal Reserve Bank of St. Louis shows that short-term (1-year) Treasury rates tend to follow the Fed Funds rate pretty closely. But when you move out to ten year maturities, there is very little correlation. Long-term rates—whether it be government securities, corporate or municipal obligations—are driven by market forces, by supply and demand and buyer expectations around inflation and the economy as a whole. Corporations and consumers can lock in these longer-term rates or yields pretty much independently of whatever is announced at the FOMC meeting.
Should we just ignore the Fed’s periodic announcements? The answer for the average investor is probably: yes. The only proven way to make money in the investment markets is to tune out the chatter and let all the workers who wake up every morning and go to work at their various jobs create value in the stocks you own, day by day, over the long haul. Everything else—even pronouncements by the mighty Fed—is meaningless white noise.
Article adapted with permission of financial columnist, Bob Veres.
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