PMC Weekly Review – December 28, 2018

A Macro View – Don’t Fight the Fed?

To say markets have been choppy lately is an understatement. A handful of catalysts have sparked the recent bumpy ride, but could the President’s increasingly frequent critiques of the Federal Reserve (the Fed) be amping up volatility in an already nervous market?

The Fed, established in 1913, operates as the US’s central bank and, among other focuses, serves an important role in setting the country’s monetary policy. When created, the Fed’s private and public leadership was seen as an improvement over the previous and predominately privately owned systems in setting monetary policy oversight. Twelve regional bank presidents (only five of which have voting power at any time) are selected by their respective regional commercial bank representatives, whereas seven individuals are chosen by the President of the United States and confirmed by the Senate to serve on the Board of Governors. Not unlike many other central banks around the world, these members work to meet the Fed’s mandates (currently set to maintain stable prices and maximize sustainable employment) and, at the same time, remain apolitical and unbiased toward the political party in power. However, the latter has not always held true, producing clear examples of subsequent actions that led to turbulent financial markets.

One of the clearest and most recent international examples of political intervention in a central bank’s policies comes from Turkey this past July. In the wake of President Tayyip Erdogan’s re-election and appointment of his son-in-law to the finance minister position, the Turkish central bank left interest rates unchanged despite concerning inflation and market participants’ expectation of a rate increase to stall rising prices. Both Turkey’s financial markets and its currency plunged after the announcement to hold rates steady, and bond rating agencies downgraded the Turkish sovereign debt the following month. Closer to home, the US Fed’s independence was challenged in the early 1970s by then-President Richard Nixon. President Nixon already had a less-than-favorable view of the Fed prior to assuming the presidency in 1968, but under pressure to be re-elected in 1972, coerced the Fed chairman into a more dovish monetary policy stance to keep easy money flowing into the economy. Soaring inflation, and eventually stagflation, came about in part from these policies, with the inflation rate reaching highs not seen since the end of World War II, and eventually topping 12% in 1974.

These are only a few of many examples of cases in which intervention into a central bank’s mandate has seemingly caused calamity. Maybe rightly so, these interferences are viewed as deviations from practiced norms and are not unlike other unforeseen events that spook investors.

Only time will tell whether the current administration’s criticism and attempts at intervention will result in history repeating itself. However, through these times of heightened uncertainty, investors should remember that market volatility is occasionally expected, and those who maintain a long-term focus have the best chance of meeting their long-term objectives. 

Eric Halverson

AVP, Investment Analyst

Source: St. Louis Federal Reserve Bank

Download the full PDF

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this weekly review is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results.

Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet|PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) securities are subject to interest rate risk, which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates. Exchange Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Investing in commodities can be volatile and can suffer from periods of prolonged decline in value and may not be suitable for all investors. Index Performance is presented for illustrative purposes only and does not represent the performance of any specific investment product or portfolio. An investment cannot be made directly into an index.

Alternative Investments may have complex terms and features that are not easily understood and are not suitable for all investors. You should conduct your own due diligence to ensure you understand the features of the product before investing. Alternative investment strategies may employ a variety of hedging techniques and non-traditional instruments such as inverse and leveraged products. Certain hedging techniques include matched combinations that neutralize or offset individual risks such as merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. Leveraged products are those that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse products utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. As with all investments, there is no assurance that any investment strategies will achieve their objectives or protect against losses.

Neither Envestnet, Envestnet|PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.

© 2018 Envestnet. All rights reserved.