Must-know: The Fed’s monetary policy since the Great Recession

Phalguni Soni

Key investor takeaways from the Fed's July FOMC minutes (Part 2 of 9)

(Continued from Part 1)

July FOMC meeting minutes

After the 2008 financial crisis and the Great Recession, monetary policy has been designed to boost economic growth and create jobs. The Fed has kept the federal funds rate at near-zero levels since December, 2008.

The federal funds rate is the Fed’s main monetary policy tool. The Fed can control the supply of liquidity in the market by increasing or decreasing this rate. Changes in the federal funds rate also translate across to rates on the Treasury yield curve (IEF). This affects returns on fixed income investments including high-yield bonds (JNK) and real estate loans (IYR), the iShares 7–10 Year Treasury Bond ETF (IEF), the SPDR Barclays Capital High Yield Bond ETF (JNK), and the iShares U.S. Real Estate ETF (IYR).

Investors should remember that bond prices move opposite to yields.

Quantitative easing (or QE)

The Fed also embarked on three rounds of quantitative easing (or QE) by purchasing securities in the open market. QE bloated the Fed’s balance sheet to over $4 trillion—an unprecedented level. Low rates and market liquidity stimulate business investment. Business investment creates jobs.

Tapering asset purchases

The Fed has slowed monthly bond purchases—a process known as tapering. At the July meeting, the Fed announced tapering monthly bond purchases by $10 billion, to $25 billion per month. However, the federal funds rate is still at near-zero levels.

Normalization

As economic growth picks up, the Fed looks to normalize its monetary policy. Recent improvements in the labor market have exceeded the Fed’s expectations. The unemployment rate dropped to 6.1% in June—ahead of forecasts. The manufacturing sector has also shown steady growth. This has boosted corporate earnings. It has been bullish for stocks (SPY) (QQQ) this year.

The Fed’s July minutes discussed monetary policy normalization. This included raising the federal funds rate. The next part in the series will discuss using tools to increase the federal funds rate.

 

Continue to Part 3

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