When the economy was in deep trouble in 2008 the Federal Reserve Bank acted quickly to increase liquidity in the financial markets. Their objectives were twofold:
- Lower interest rates in order to stimulate the economy (recall the deep recession we were in)
- Prevent the financial system from freezing up (recall that many banks and brokerages were on the brink of insolvency)
They deployed several policy changes to implement these strategies which included:
- Lowering the Fed Funds Rate to zero (this is why interest rates are historically low)
- QE or Quantitative Easing (open market bond purchases to improve the balance sheets of the banking system)
- Operation Twist (brings down long-term interest rates helping home buyers)
In my opinion the measures the Federal Reserve took were necessary to avoid a depression scenario back in 2008. In hindsight, it appears Fed policy helped pull us out of the recession, grow the economy, and clean up the banking system. Let’s look at some broad charts of the economic recovery:
GDP recovered and has been growing approximately 3% on a year over year basis (that’s good)
Unemployment has gotten much better (that’s good)
Finally, the consumer has been steadily gaining confidence and spending again (that’s good)
Last but not least, the stock market has recovered and is hitting new highs (that’s good)
There have been plenty of Fed policy critics these past 5 years. Critics have been warning us for years that Fed policy would cause runaway inflation, higher interest rates and a weak dollar. In reality:
- Inflation has hovered around 2% for the past several years (below the Fed’s target of 2.5%)
- Interest rates have remained at 30 year lows
- And, the dollar has strengthened versus most currencies around the globe
One argument many Fed detractors make is that QE helps Wall Street and the wealthy more than it does Main Street. I would agree with this. QE has benefited the banking industry by bolstering the quality of their balance sheets, but what about the consumer?
QE programs have a “wealth effect” that via lower interest rates tends to boost stock and home prices. The Fed hopes the consumer will benefit if their stock portfolios and home prices rise and will spend more which will juice the economy. The problem with this is that most middle class Americans don’t own enough stocks to really benefit from this effect. Lower interest rates have allowed many homeowners to refinance their homes, but rising stock prices unfortunately don’t affect the middle class much.
Regardless of the critics, I believe aggressive Fed policy was the right direction to go in 2008. Yes it took longer than expected for the economy to recover, but it has recovered and now the Fed is winding down (tapering) its QE programs.
Europe decided to go in a different direction in 2008. Instead of stimulating the economy they decided to implement austerity measures (slashing government spending, cutting debt and raising taxes) during the recession. Austerity failed in Europe and has kept their economy stuck in recession territory. Now Europe is finally resorting to stimulating their economy like the Fed did back in 2008.
I think the Federal Reserve made the right decisions and our economy here is proving it. If I were grading the Fed I’d give them an B+.
As of September 15th, 2014:
Dow Jones US Moderately Conservative Index is up 5.13% (TR) for the year
S&P 500 closed at 1,985.54 up 8.91% for the year
U.S. 10 year Treasury Futures are yielding 2.59% down 0.38% for the year
WTI Crude Oil futures closed at $92.92 down $5.78 for the year
Gold closed at $1,235 per ounce up $31 for the year
To expand on these market reflections or discuss other portfolio strategies please don’t hesitate to reach out to the Gradient Investment team.
