Janet Yellen, the first woman to be Chair of the Federal Reserve, had the markets moving last week after the latest announcement on the Fed’s plan for market recovery. The Federal Reserve Bank, commonly called the Fed, recently announced some future changes to its monetary policy that will have a large effect on markets and the economic recovery throughout the year. The Federal Open Market Committee (FOMC), whose members vote on economic policy issues, recently met on March 19th to discuss bond purchases and raising interest rates. Since 2008, The FOMC has been buying Treasury bonds to lower long-term interest rates to help support the economy in addition to its usual methods of controlling short-term interest rates.
However, that might soon change since the Fed announced that it would reduce its monthly bond purchases to $55 billion and will plan to gradually raise short-term interest rates. FOMC member Charles Plosser, current president of the Philadelphia Federal Reserve Bank, added that he expects the Fed’s bond-buying program to end by November and for short-term rates to rise to 3 percent by the end of 2015. Janet Yellen, the Fed Chairwoman, was less optimistic about the rebounding economy and plans to keep short-term interest rates down until after the bond-buying program ends and inflation picks up.
The market reacted to this news by sending stock and gold prices down and sharply increasing the yields on bonds. Despite Janet Yellen’s assurances of a smooth and timely transition, investors took away that the Fed is planning on higher interest rates sooner than expected. When interest rates go up, more people are willing to lend money because they can expect a higher return on the coupon payments, which is the interest payment on the bond. Typically, bonds and stock prices work like a see-saw, when bond prices go up stock prices go down. This happens because people invest in stocks when the market is booming so the return on a stock investment is more than the interest earned on holding a bond. However, in a downturn, bonds are seen as safe since they usually don’t crash like stock prices can and investors can depend on the steady interest payments.
Not all are fans of the proposed higher interest rates, fearing that the Fed may move faster than originally planned. The National Association of Business Economists (NABE) issued a survey that reveals economists think rising interest rates could hurt the economy’s recovery. The Fed is between a rock and a hard place since raising interest rates too fast risks destabilizing the slowly recovering economy but not moving fast enough might allow the economy to bounce back too quickly. For now, everyone just has to wait and see before the next move can be made.