The current Federal Reserve was officially created in 1913 as an entity to create stability and give the public faith in the banking system again after a major financial crisis that seemed to peak in 1907. According to the Fed, its mandate is to “promote sustainable, high levels of employment, stability of prices to help preserve the purchasing power of the US Dollar, and moderate long-term interest rates” in the United States. On the surface it seems simple. Do what is best for the United States to maintain our status as a leading economy.
Today the U.S. is the largest developed economy. Economic and market actions in the United States generally effect the global markets. We live in an age of a much tighter global economy between our trading partners. Our corporations do not just look at domestic sales numbers, they now look at global sales numbers. About 15-20 years ago, it would have probably surprised most Americans that about half of General Motors sales were outside the United States. Now, let’s fast forward to 2014 and domestic sales only account for just under 30% of General Motors annual sales. For the majority of our large US corporations, the foreign side of their sales numbers generally in excess of 50%.
So keeping this globalization shift in mind, why would it surprise you that the Fed’s mandate would not shift as well? The problem is in the United States we have this “us versus them” nationalistic mentality where many pundits have not fully adapted to this globalization shift. As consumers and stock holders we love the benefits of globalization, but don’t tell me I need to be conscious of the mess being remedied in Europe when we here in the United States have already worked through those problems. “Can’t believe the Fed cares about what his going on in China and Europe. It’s the US Federal Reserve, they should only be paying attention to the US.” That is a summary of what you generally hear now days after the Fed decided not to raise rates in September.
After months of speculation the Fed finally publically disclosed that they wanted to see market stability with some of our major trading partners before pulling the trigger, with the thought that a rate hike could further shock what was already an unstable international market. The problem is the way the message was interpreted by the markets created greater concern for these recovering economies, as well as our own, causing the markets to spiral further out of control. So should the US Fed really be taking these foreign economies into consideration when determining the path of the US interest rates? Yes. We are a major player, amongst other large players, in a global marketplace. These are our global trading partners that account for well over half the revenues of our domestic companies. If you want our US corporations to continue to prosper, you need to assist to make sure that there trading partners are healthy.
If these global economies are not healthy enough to purchase goods and services from our US companies then US companies will have to trim back. That could cause greater unemployment here in the United States. But remember the Fed’s mandate needing to promote sustainable and high levels of domestic employment? If a country’s economy continues to falter, that will have adverse effects on that country’s currency and its ability to trade with the US. If the US Dollar gets too strong, that makes our goods too expensive for these foreign consumers to purchase and they will then look for cheaper substitutes produced by other countries. Eventually this will affect the bottom line of US corporations. Again, this harkens back to the Fed’s mandate of needing to sustain prices and help preserve the purchasing power of the US dollar, not just domestic but also abroad. Also, sustainable domestic employment, if a company’s bottom line is affected. Based on this, are you still surprised about the Feds actions in September?
I still believe we will see some move by the Fed by the end of this year. Not that a .25 point increase in interest rates will really have such a huge impact,( though there will likely be a short term shock to the system) but it is the message sent by the move. The move signals an endorsement that the economy is moving in the right direction. A message of confidence. Now that the Fed has finally disclosed they are taking the condition of foreign markets into consideration, it will also be a positive endorsement of the actions of other central banks and that their markets can handle that initial shock to the financial system. Additionally, you should not be surprised to see the global markets rally when the Fed finally does take action. Besides the boost of global confidence a Fed decision will administer, it will finally get a lot of companies moving again that have been sitting around looking for monetary direction. After the Fed makes a move, do not be surprised if it takes a while until the next move. This will be a slow and steady adjustment over the next 2-3 years. If they have not been in a hurry to make a .25% move, can not see them rushing to get us up to that 1-2% range.