With recent headlines swirling around the appointment of a new Federal Reserve Chair, it’s natural for investors to wonder what this means for markets, interest rates, and their portfolios. The Fed receives outsized exposure in the financial news, and after the inflation shock of 2022, it’s easy to assume this attention reflects a similarly outsized impact on economic outcomes.
But that assumption gives the Fed more credit than it deserves.
To understand why, it helps to step back and look at what the Federal Reserve is actually tasked with doing, and just as importantly, what it cannot do.
A Recent History of the Fed
The Federal Reserve operates under a dual mandate: maintaining price stability and supporting maximum employment. These goals often pull in opposite directions.
As the pandemic spread in 2020 and 2021, the government determined there would be no practical limit to the fiscal support provided to keep the economic train moving. In 2022, inflation surged on the heels of this unprecedented money printing. In effect, price stability was sacrificed in favor of supporting employment.
In response, the Fed raised interest rates. This followed well-regarded economic theory, which clearly states that when inflation is high, one way to bring it back down is by raising rates. At the time, there was widespread concern that these actions would restore price stability but potentially push the economy into recession. That recession, fortunately, never fully materialized.
There was a heckuva lot more that occurred during this period, but the synopsis above reinforces one overarching belief among investors: that the Fed has an overwhelming impact on economic outcomes and financial markets. That belief gives far too much credit to the Fed and far too little credit to deep, liquid capital markets, and how they function.
What the Fed Controls
The Fed directly controls a very specific part of the interest-rate landscape: ultra-short-term rates, collectively referred to as the federal funds rate.
For a large corporation with thousands of employees that doesn’t want to hold excess cash in a checking account to meet payroll, it may instead take overnight loans at the federal funds rate to meet its obligations. If or when the Fed lowers this rate, that’s a benefit to the corporation.
If, on the other hand, you are a saver who puts money into CDs, those CDs invest in short-term instruments. When the Fed lowers rates, you’re going to see the rates on CDs move lower as well. In other words, when the Fed acts, its influence is felt most clearly at the very short end of the interest-rate spectrum.
Where that influence begins to fade is as we move further out in time. What’s fascinating is that the Fed is often not a driver of long-term rates.
For example, if you look at mortgage rates, the foundational base for mortgages is actually the 10-year Treasury, not the federal funds rate. Take the 10-year Treasury, add a “spread” to account for the longer time horizon and the fact that banks need to earn a return, and that combination results in your mortgage rate.
If we focus on 2023, when short-term rates were high, the Fed held the federal funds rate steady until September of 2024. Over that time period, with the Fed taking no action, the 10-year Treasury dropped by over 1%! Then, in September 2024, the Fed cut rates three times for a total of about 1%, but get this: the 10-year Treasury went up.
So, these two rates do not always move in the same direction. The 10-year Treasury has a mind of its own and is driven by many factors. One of the most important is expected future inflation, which often plays a larger role than the actions of the Fed.
Reframing the Fed
None of this is to say that the Federal Reserve is irrelevant. Its actions matter, particularly at the short end of the yield curve. Problems arise, however, when investors treat the Fed as the primary driver of long-term market outcomes.
A more useful framework is to recognize that:
- The Fed reacts to economic data.
- Markets react to expectations about the future.
- Long-term returns are shaped by much, much more than Fed actions.
Instead of focusing on predicting the Fed’s next move, investors are better served by (a) understanding what the Fed actually controls and (b) acknowledging that market prices always result from a mix of many forces, even when headlines point to just one.
When we stop overestimating the Fed’s influence, we gain a clearer perspective on what truly matters for long-term investing. That clarity leads to better decisions, regardless of who sits as Fed Chair.
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CONSIDER
Three ideas that feel dismissive of expertise, but illustrate the mindset required to innovate:
“Ideas are fragile and they’re easily knocked away by everybody. That’s why experts are dangerous.” – James Dyson
“It is impossible to lead by following therefore I am different.” – Christian von Koenigsegg
“If I ever wanted to sabotage my enemies, I would fill their ranks with experts. They know so much about why something won’t work they’ll never get anything done.” – Henry Ford
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Let’s get after it this week!
Brooks
Brooks Palmer, CFP® is Head of Investments at Root where he helps identify, evaluate, and implement investment solutions tailored to clients’ needs. In Full-Court Press, he breaks down what’s happening in the markets—cutting through the noise and jargon—while connecting it to Root’s core investment tenets so you can make the most of your money and your life!
The examples provided are hypothetical and for illustrative purposes only. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The information presented should not be construed as investment advice or a recommendation to buy or sell any security or implement a particular strategy.
Advisory services are offered through Root Financial Partners, LLC, an SEC registered investment adviser.