The Federal Reserve Announcement - What Does It All Mean?
posted on Wed, Sep 20, 2017
One of the most frequent questions I get is some variation of “The federal reserve is making an announcement, so what does that mean for my portfolio?”. It just so happens the federal reserve made an announcement today, so let’s try to break it down.
Janet Yellen, the Federal Reserve chair, announced the following:
- They are keeping the benchmark U.S. interest rate at 1% - 1.25%.
- The recent hurricanes may affect short-term economic indicators, but should not derail any economic expansion.
- The central bank is initiating a balance sheet normalization program in October.
In the wise words of Austin Powers, “What does it all mean Basil?”
The first two bullet points are self-explanatory, but what is balance sheet normalization? To help answer that we need to take a trip down memory lane. During the financial crisis in 2008 the Federal Reserve started a practice called quantitative easing. When panic hits the market, investors tend to keep selling which keeps driving the price down and makes it difficult for the market to stabilize. As a result, the Federal Reserve bought up trillions of dollars of mortgages to ease the burden on the banks and the fears of investors. This practice gives the banks more money to lend out (at lower rates) and hopefully results in the economy to stabilize and start moving.
This is all well and good, but eventually the Federal Reserve needs to sell the mortgages they bought or else they cannot do it again in the case of another financial crisis. Without getting into how the sausage is made, the result of this self-off may be higher interest rates, a stock market correction and slower economic growth.
That begs the question of what should you be doing to your investment portfolio? All signs point to this being a slow transition, so it does not look like you need to do anything major. The Federal Reserve is not making any drastic moves, they are trying to make a long-term proactive move. You should use this as an opportunity to make sure your portfolio has adequate levels of low volatile investments that coordinate with your risk tolerance and needs. In addition, you may want to consider some “defensive” sector investments (utilities, health care and consumer staples) to help lower the overall volatility of your portfolio.
Please feel free to contact me anytime to discuss this topic or any other in more detail.