Watching the “Fed” – What’s Next?

During the tech bubble recession, the Federal Reserve (“the Fed”) reacted by lowering the Fed funds rate13 times in a row from January 2001 to June 2003. The Fed then raised the rate 17 times in a row from June 2004 to June 2006.

Then, 2007 brought the collapse of the housing market boom, setting off a drop in mortgages which contributed to the worldwide credit crisis and the Great Recession. This time, the Fed reacted by lowering rates 10 times from August 2007 to December 2008.

For the last seven years, while interest rates have stayed near zero, an entire ecosystem has been built around low-cost credit, which could be disrupted should the Fed start raising rates again.

The Fed has been saying for some time now that it expects it will need to raise interest rates to maintain a stable equilibrium funds rate level. The equilibrium level is achieved by the Fed manipulating interest rates to reach its goal of full employment and stable inflation. Thus far, the Fed has held its equilibrium funds rate to what some believe to be a depressed level in order to jump-start the economy.

Now, with unemployment levels in the 5 percent range, the Fed is concerned that if unemployment continues to drop there could be a labor shortage, which could in turn push up wages—this is what some contend to be the biggest driver of inflation. But at this point, it is questionable whether wage growth is really a problem.

According to the Bureau of Labor Statistics, inflation-adjusted average hourly wages for non-management private-sector workers have been stuck in a range of around $20 an hour since 1964, whether the economy was expanding or not. The actual peak was in 1973, at $4.03 an hour, which equates to $22.41 today. Wage growth has been so constrained for so long that there is now a nationwide movement to raise minimum wages to a “living wage.” But even if this movement is successful, whether or not it will drive inflation is questionable.

The Fed has been patient, as it likes to say, but may lose its patience if it becomes clear that we are not simply stuck in what economists are calling “secular stagnation.” This would mean that instead of just going through a cyclical period of slow growth and low inflation, we could be in a longer-term transformation into a slow-growth or a steady-state economy.

On the other hand, some economists theorize that the economy is strong, that it is simply being buffeted by temporary headwinds such as the protracted deleveraging of banks and consumer debt. Meaning it is possible that the weak gross domestic product figures could belie an underlying growth that we are experiencing anecdotally.

Finally, reacting to radical shifts in the economy, between January 2001 and December 2008, the Fed raised or lowered the Fed Funds rate 40 times. Since 2008, it seems to have adopted its usual wait-and-see attitude, poised to act should wages or inflation go up. And, again, history seems to prove it will, in fact, act.

But wages and inflation are lagging indicators. That is, they reflect not what will or can happen but what has already happened to the economy. So, by once again reacting to lagging indicators more than leading indicators, the Fed continues to maintain its role as a force to get us out of trouble, not to avoid it.

About Nick Stonnington

Nick Stonnington has been a wealth advisor since 1983. He founded Stonnington Group in 2004 to better serve clients by offering them a platform for independent fiduciary advice. The Stonnington Group team manages client investments and advises on their businesses. Nick was ranked #1 in Los Angeles by Registered Rep Magazine in 2002 for "America's Best Wealth Advisors." Nick's expert commentary has been featured in such publications as the Wall Street Journal, Los Angeles Times, New York Times, Investment News, and Investment Advisor. His research has been published in the Family Wealth Report and he has written articles on investing for numerous industry journals.
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