Markets, Meet Your New Federal Reserve Maestro

Federal Reserve Chairman Jerome Powell should be pretty pleased with his performance Wednesday. The central bank raised interest rates for the eighth time since December 2015, while simultaneously dropping its long-standing description of monetary policy as “accommodative” — implying that low rates are no a longer tailwind for the economy. Markets responded by taking it all in stride. It’s a bit like the 1990s, when investors enjoying buoyant markets dubbed then Fed Chairman Alan Greenspan the “maestro” for what they perceived at the time as his skilled stewardship of monetary policy.

Bonds rallied, the dollar weakened, and although stocks fell in the final half hour of trading, it could have been much worse. What makes those moves all the more remarkable is that the Fed also reiterated its plan to raise rates again in December, and at least three more times in 2019. Two thoughts help to explain the response of markets. First, the removal of the word “accommodative” after so many years means that the central bank is that much closer to the end of its rate-hiking cycle. The target for the federal funds rate has risen from 0.25 percent in 2015 to 2.25 percent, and many think the Fed will stop at 3 percent or 3.25 percent. Second, markets in recent years haven’t responded to rate increases as conventional wisdom would suggest. Remember when the Fed began tightening monetary policy in back in December 2015, and everybody said that it would be the end of the rally in equities, cause the bond market to collapse, and spark such a rally in the dollar that U.S. companies wouldn’t be able to compete in the global marketplace? Well, none of that happened. The reality is that the S&P 500 has gained 41 percent to an all-time high, the Bloomberg Barclays U.S. Aggregate Bond Index has gained 4.49 percent — not something to celebrate, but not the train wreck many predicted — and the Bloomberg Dollar Spot Index has fallen 4.16 percent. What most prognosticators failed to acknowledge is that central banking has become so transparent that forecasting rate moves has become the most predictable game in town.