Fed Relief Rally

Following a Christmas Eve market low, Santa Claus delivered a strong stock market rally that lasted the next three months. The fourth quarter drop in market prices was a significant jolt to investors. However, major market indices are once again knocking on the door of all-time highs.

In general, the strength of consumers and corporations did not change. They remain relatively strong by historical standards. Inflation remains muted and employment is strong. At the end of December, prices reached a lower level that prompted investors to take advantage of relatively attractive prices and start purchasing shares again.

A few other items helped propel the rally farther:

• More productive trade talks between the U.S. and China.
• The European Central Bank indicated they would will not raise their interest rate in the foreseeable future, maintaining a negative 0.4% interest rate in the Eurozone.
• The U.S. Federal Reserve followed suit and indicated they are likely to hold target interest rates at current levels for the remainder of the year.

The federal funds rate is the interest rate at which depository institutions trade federal funds (balances held at Federal Reserve Banks) with each other overnight. The Federal Reserve has three primary mandates: maximum employment, stable prices and moderate long-term interest rates. To measure these items, the Federal Open Market Committee (FOMC)seeks an inflation rate around 2.0% and unemployment of 4.0% – 4.6%. These objectives currently appear well in hand; however, the FOMC does see reason to be cautious.

Following seven years of near zero rates from 2009 through 2015, the U.S. Federal Reserve began raising the target rate. Despite steadily rising rates, the current effective federal funds rate of 2.4% remains well below historic averages, as illustrated in the figure below. Gray areas on the graph indicate years of recession. Following the sharp economic recession we saw in 2008 and 2009, we have enjoyed a long period of growth.

The federal funds target rateis very important to all of us, as it helps set interest rates at which banks are willing to lend to customers as well as the rate they are willing to pay depositors. Lower rates prompt businesses to consider additional loans to help grow their business. So, lower rates are seen as positive for economic growth while higher rates are thought to prompt businesses and consumers to save and not invest in growth.

Looking forward, this interest rate environment remains very favorable. First quarter earnings reports will be watched closely for any signs of slowdown in activity or inflationary pressures. These signs will likely drive markets in April and May.