Fed Curtain-Raiser: Why the Fed Is Reassuring Markets on U.S. Economic Fundamentals - TheStreet

During today's Federal Open Market Committee (FOMC) meeting, the members of the Federal Reserve will reassure investors about the “solid underlying fundamentals of the U.S. economy" despite the recent losses, said Greg McBride, chief financial analyst for Bankrate, the North Palm Beach, Fla. based financial content company.

The recent volatility and massive selloff in the markets, which led to losses of over 10% in the major benchmark indexes amid a global slowdown and prolonged oil glut, have spooked investors. These declines have “nothing to do with our economy, and it is a message the Fed will need to drive home,” McBride said.

The likelihood of another interest rate hike in March following the first one last December in nearly a decade decreased “dramatically” with the market pullback, he said.

“An increase in January was never in the cards and was seen as a bridge between the December hike and a potential increase in March,” he said. “The Fed will reassure investors that another hike is not right around the corner.”

With oil prices also plummeting to 12-year lows and not stabilizing, there is a “renewed decline for more downward pressure on inflation numbers,” McBride added. The central bank’s stated goal was progress toward 2% annual inflation.

“This gives the Fed further rationale to keep interest rates on hold,” he said.

Plunging oil prices could hinder economic growth, and the Fed has indicated the energy sector is a “vital” component of increases, said Edison Byzyka, vice president of investments for Hefty Wealth Partners in Auburn, Ind.

“If it continues to falter, the economic losses can be severe and can cause a widespread short-term slowdown,” he said. “The severity of the slowdown will be entirely dependent on Fed actions and equity market sentiment.”

Number of Rate Hikes

Despite the fact that the Fed previously hinted at four rate increases this year, McBride believes the likelihood is greater that two or three increases will occur in 2016. Unless a recession occurs, the Fed will not reverse its previous rate increase.

The Fed could act even more bullish and raise rates three to four times or between 0.75% to 1.00% still, but the first increase is likely “a couple of months off,” said Robert Johnson, president of The American College of Financial Services in Bryn Mawr, Pa.

“They can’t reverse course and lower rates, as that will signal that they are admitting they made a mistake by raising rates and that they don’t have confidence in the economic recovery,” he said. “The volatility is due to global economic concerns — specifically China and the precipitous fall in oil prices.”

The central bankers did not make a mistake in raising interest rates in December because it was “warranted,” Johnson said.

The prospect that the Fed will raise rates more than once is not probable, said Byzyka.

“The Fed will likely make one more hike in 2016 which will occur in the second half of the year, he said. “Given recent equity market volatility, including the non-stop news about a potential Chinese hard landing, the Fed will not act in March.”

Since the U.S. economy continues to grow slowly and at an “uneven pace,” there is a risk that an economic slowdown could result in a “self-fulling prophecy if consumers and businesses get sufficiently freaked out that that they cut back,” McBride said. Softness has decreased revenue growth in corporate profits across several sectors in addition to energy and growth is not as robust.

Additional market volatility will impact the Fed’s policies even though the central bankers “would like us to believe the outcome in the equity market have no implications,” said Byzyka.

“No one should believe that,” he said. “The Fed will indirectly keep interest rates at current levels and will be guided by equity market volatility. Relative to other parts of the world, U.S. households hold a significant piece of their wealth in the equity market.”

Effect on Consumers

The recent slowdowns in the economy and stock market have pushed mortgage rates, which are tied to the 10-year Treasury note, back below the 4% mark. This decline bodes well for potential homeowners, but the low rate is a short-term move aided by the “nervousness and downswing” in the financial markets, McBride said.

“Once the sky is clear, it will move back toward the 4% mark,” he said.

Notwithstanding the benefits of cheaper gas prices, consumers are not spending the savings they have garnered from the 18-month decline in gas prices, Byzyka said.

“The notion that they’re spending more because of the savings is wrong and it should not be entertained, he said. “We’re in a period of historically low wage growth, which means that excess consumer spending will need to come in the form of new money, so to speak, not from saving at the pump.

The losses in the market could lead to lower consumer spending, said Mike Davis, a strategy and economics professor at Southern Methodist University’s Cox School of Business in Dallas.

“Market volatility seems to be inconsistent with real economic news, but you always have to wonder whether the market is seeing things that we don’t see in the data," he said. “Volatility increases the possibility of another crisis, which I still don’t think is very likely. No one has a clear understanding of what’s going on in the global economy.”