by Connor Darrell, Head of Investments
Equity markets around the globe managed to climb higher last week as they recovered from a difficult start to the month. The constant strategic pivoting in the trade negotiations between the U.S. and its global trading partners (particularly China) has been the primary catalyst for markets over the course of 2018, and we expect this to remain the case at least until the mid-term elections in November. For better or for worse, polling data may begin to influence the aggressiveness of President Trump’s negotiating tactics as he strives to rally voters and keep the Republican majority in the legislative branch. In the meantime, investors will need to keep focusing on fundamentals and accept that daily headlines may foster a particularly “noisy” few weeks.
August inflation data indicated that prices rose 2.7% year over year, marking the first month in 2018 where the rate of inflation cooled. The Federal Reserve’s next policy meeting is next week, and markets are expecting another 0.25% interest rate hike.
Monetary Policy Primer
With the Federal Reserve meeting again next week, we thought it might be a useful exercise to discuss the basics of monetary policy and the role of the central bank in monitoring/influencing the economy.
As the U.S. economy emerged from the depths of the financial crisis, the Federal Reserve implemented multiple rounds of an aggressive monetary policy initiative known as quantitative easing (QE). At its core, QE involves actively purchasing bonds on the open market while simultaneously lowering the short-term interest rate in the economy. Both actions work together to keep interest rates on all maturities artificially low. The theory is that lower interest rates make it more palatable for businesses to borrow money and invest in growth opportunities, stimulating the economy. Ten years later, rates are still very low in historical terms, and the U.S. stock market has benefitted from the decade of “easy money” policies. However, as the economy heats up and evidence mounts that it can stand on its own footing, the Federal Reserve must now unwind its actions and begin pushing the economy to a more “normal” state.
The influence of the central bank has certainly expanded during the 21st century, and QE was in many ways an experimental policy. Never in history had central banks implemented such a bold and large-scale policy initiative aimed at actively combating a recession. So far, with the U.S. economy looking quite healthy, it appears to have been a success. But it should be noted that we have not yet seen this play out in its entirety, and only time will tell whether the policy was optimally implemented. The one thing that seems certain however, is that it helped to support the U.S. stock market over the past 10 years. Following the 2008 recession, the U.S. stock market took only four years to recover and reach its previous highs. This is in stark contrast to the recovery following the Great Depression, when it took more than 10 years, plus the organic stimulus of a world war, to finally reach the previous market peak.