Today, the Federal Reserve raised interest rates by another 25 basis points. The central bank of the United States is in charge of raising and lowering rates to maintain economic price stability and help maximize employment.
The March 2023 rate hike signals that the Fed is still fighting higher prices – also known as inflation – now.
The Fed has been the primary driver of market speculation for the last 20 years. The Fed emerged in the early 20th century as an agency to help prevent the boom-and-bust cycles of the late 19th century.
But, I’ve argued that the Fed is now responsible for the boom and bust cycles of the 21st century. My statement is largely unimportant to someone wanting to understand one basic question.
What does the Federal Reserve do?
I’ll explain right now.
What Do You Do, Mister Powell?
The Federal Reserve system (a.k.a. “The Fed”) is the central bank of the United States.
It’s in charge of managing monetary policy to control inflation, maximize employment, and ensure the stability of long-term interest rates.
There are three primary responsibilities that the Fed holds.
- Monetary policy is the management of the U.S. money supply. Although the Treasury Department physically prints money, the Fed manages the amount of money sloshing through the system by adjusting interest rates, managing its balance sheet, and setting bank reserve requirements. One additional guideline within the monetary policy is the Fed’s efforts on Forward Guidance. I’ll discuss why this matters in a moment.
- Next, the Fed is in charge of providing stability to the global banking system. The Fed uses its balance sheet to buy and sell bonds and other assets to provide capital to the system. Typically, during a crisis, the central bank is the buyer of last resort of U.S. assets. In addition, the Fed will provide capital to struggling banks like we just witnessed with regional banks to shore up the system.
- Third, the Fed supervises and regulates banks. The central bank engages in stress tests and analysis of the safety and soundness of the thousands of banks in the United States. In addition, it oversees the banking system’s compliance with laws and regulations. It’s also in charge of promoting consumer protection in the banking system. We’re watching you, Wells Fargo (WFC).
So what did the Federal Reserve do today? And why does forward guidance from the Fed matter?
Powell Warns
The Federal Reserve did raise interest rates by 25 basis points as part of its efforts to curb inflation. The central bank also laid out expectations for at least one more rate hike in 2023.
But there was another important element that has helped provide support to the market…
The Fed’s “Dot Plot,” which measures expectations for the central bank’s interest rate moves in the future, shows an expected effort by the bank to cut rates three times in 2024.
This would effectively end the rate-tightening cycle for the stock market, and hopefully, align with a reduction in inflation moving forward.
In addition, the Fed’s economic outlook was pretty bleak. While Federal Reserve Chair Jerome Powell signaled stability in the banking sector, the Fed had signaled that economic growth would come in between 0% and 0.8% this year.
That’s not good.
This will likely create additional pressure as we eye stocks in the second half of 2023.
Typically, the market will reflect recessionary challenges. While the government will likely do all it can to prevent a technical recession, it’s very clear that the markets are under stress.
They are under stress… because of what the Federal Reserve does.
It’s raising interest rates still in a recessionary environment.
To your wealth,
Garrett Baldwin
Market Momentum is Red
The market didn’t really appreciate the Fed’s comments today. While volatility declined, the S&P 500 pulled back under that critical 3,990 support level. We’ll wait to see how institutions behave and if they will use short-term pops to sell. This is a very tricky market. Remember that cash is your friend.
