Biggest Fed Policy Change Since 2012
Biggest Fed Policy Change Since 2012
September 4, 2020
By Ian Yarberry
It is fitting that my first writing for Capital Resource Group, Inc. is about one of the largest changes in Fed monetary policy since the current policy was enacted in 2012. The Federal Reserve announced last week a “robust updating” of Fed policy that the US central bank has shifted from a explicit goal of 2% inflation to “average inflation targeting.” 1 This was echoed Friday by the St Louis Fed President James Bullard on CNBC’s “Closing Bell” that ‘… since inflation has largely been under the target by a half a percent in recent years, he’d be willing to let it “run above by a half a percent for quite a while.”’ 2
Going into the Jackson Hole conference, the Fed funds rate forecast consensus already has rates near zero through 2022. Although the Fed can change their forecast at will, like we saw in Q1 2020 going from “not wanting any changes” to drops rates from 1.75% to 0.25% in March earlier this year. 3 The Fed adopted the explicit 2% inflation target in 2012, although it was an implicit target since 1995. 4
The last time we saw “zero rates” was from December 2008 5 till December 2015 6. A controversial phrase is “its different this time” and I think to some degree, what causes bull markets, bare markets or the new “kangaroo market” from CNBC’s Closing Bell Market Zone segment on June 15, 2020 (albeit as mostly a joke) is true that there are always different underlying factors but there are generally similar factors as well. One difference was in December 2008, the 10-year US Treasury was at 2.25% on December 31, 2018 7. However, this time, the 10-year US Treasury had already dropped below 1% on March 3, 2020, breaking back above on the 18th and 19th, before staying below ~0.75% through August. 8
During the last near zero rate period of 2009–2015, the S&P 500 had a 10% intra-year decline in 5 out of 7 years, although it finished positive all 7 years. Having bonds in a portfolio generally lowers the overall risk of the portfolio but it’s generally with a decrease in potential return too. 9
If you are within 5–10 years of retirement or in retirement, you most likely have some exposure to bonds and fixed income as you are getting closer to shifting from the accumulation phase to the preservation or distribution phase of retirement planning. According to Morningstar, there was $2.3 trillion at the end of 2019. For target-date 2020 funds, for investors retiring this near year, there is about a 13% difference in equity exposure and 10% difference in target-date 2015 funds across various mutual fund families. 10
The longer interest rates are kept near zero, the longer the yields in core and investment-grade bond funds will decrease as they will have to continue to purchase new bonds at the lower yields as their old bonds with higher coupon payments mature or are called.
We still believe in asset diversification, but it is again very prevalent to keep a close eye on what is in difference bond funds as some funds with more flexibility shift their “chase for yield” into higher risk assets. This can be a good shift but only if it fits into your whole portfolio and stays in line with your goals.
Contact us today to review your investments to see how this shift in the Fed’s policy might affect your portfolio and what, if any, changes might need to be made to keep you on your course before or after retirement. Only time will tell how this new policy will affect the economy and stock markets, but it is reasonable to think that with rates back to near zero, having a diversified portfolio can be challenging but still necessary. However, as this year has shown, market pull backs do happen and can happen and still owning bonds and fixed income can help lessen these affects.
10 Morningstar. May 2020. “2020 Target-Date Strategy Landscape” Chicago, IL. Morningstar Manager Research
The opinions and forecasts expressed are those of the author and may not actually come to pass. This information is subject to change at any time, based on market and other conditions and should not be construed as a recommendation of any specific security or investment plan. Past performance does not guarantee any future results. The author uses what they deem as reputable sources but is not responsible for the validity of their information.