The stock market is not—repeat, is not—part of the Federal Reserve’s mandate. But maybe that is changing, if not in the Fed’s official mission statement, at least in practice.
That’s the conclusion of Michael Arone, chief investment strategist for State Street Global Advisors US Intermediary Business Group. Now, employment and inflation are the official concerns of the Fed. The central bank’s policymaking arm, the Federal Open Market Committee (FOMC), never cites market movements in its decisions.
The stock market, though, is a part of the economic system, and Arone finds the Fed’s pooh-poohing of market reactions absurd. “FOMC members always dance around the role capital markets play in their monetary policy decisions,” he wrote in a recent research paper. “But it’s time they come clean.”
After the July 31 move to lower short-term interest rates for the first time in a decade, albeit by just a quarter-point, Fed Chairman Jerome Powell cited the US-China trade war and slowdown in Europe and China as concerns that merited an “insurance” cut. That sentiment was reinforced by the FOMC’s minutes from its last meeting, which were released Wednesday.
That explanation for the rate reduction prompted Arone to wonder: “Why should any of these global concerns matter if employment and inflation in the US are the Fed’s only mandates?”
Sure, only a small sliver of the population owns stocks. The top tenth of the population by wealth has 84% of the stocks. Yet Arone pointed out that, thanks to retirement plans likes 401(k)s, about half of US households are in the market. And while stocks amounted to less than half of gross domestic product in 1980, they now are valued at $30.5 trillion (as of the start of 2019) and that’s 150% of GDP.
The market’s loss of $2 trillion in late 2008, amounting to a halving its value, sent consumer confidence plunging, and stocks took nine years to regain their pre-crisis level. Previous, less precipitous market declines “barely budged” the confidence index, Arone wrote.
“Equity levels impact valuations and cost of capital, and influence corporate hiring and spending decisions,” Arone maintained. So the next time you hear a Fed justification for its actions, you likely will see a third mandate, the market, between the lines.