Fed embarks on unprecedented maneuver

Last week's economic data made it perfectly clear: hurricanes have muddied the economic waters.

This lack of “clean” economic data will make it difficult for the Federal Reserve, our nation’s central bank, to get a solid grasp on the state of the U.S. economy. So, when the Federal Reserve meets this week, they will likely leave short-term interest rates unchanged. However, the Federal Reserve is expected to announce that it will begin to reduce the size of its $4.5 trillion “balance sheet.” The Federal Reserve grew the balance sheet from about $900 billion in 2008 to its current level by buying mostly treasury and mortgage bonds to help the economy get out of the grips of the 2008 financial crisis, and it worked. Since the economy is no longer in a state of emergency, the Federal Reserve is going back to its normal operating procedures. Simply Money Advisors expects the Federal Reserve to shrink its balance sheet, slowly, by about $2 trillion over the next four years. However, the Federal Reserve may have to adjust the pace depending on changing economic data. How this plays out in the coming years is important to you, because both the stock and bond markets have become dependent on the Federal Reserve’s programs since the Great Recession. Simply Money Advisors will be watching this closely for you as it unfolds.

The most recent economic data on retail sales was underwhelming. Not only did consumer spending in August come in well short of expectations, but prior months were also revised lower. This suggests you, the consumer, are not as ready to open your wallet as the data initially suggested. So, while August's poor reading can be somewhat attributed to Hurricane Harvey (it made landfall in Texas on August 25th), the prior months' revisions cannot. This lack of spending could keep inflation contained, and that should keep the Federal Reserve from aggressively raising interest rates.

With this sluggish spending, many economists expect economic growth to come in around 2.3% for the third quarter (July, August, September). Plus, there could be further reductions in the third quarter's expected economic growth because of Hurricanes Harvey and Irma: Moody's (a company that rates bonds) estimates a total of $150-200 billion in damage and a further $30 billion in lost economic output for this quarter. However, much of this will be gained back in October, November, and December due to rebuilding efforts. 

The Simply Money Point 

No central bank has ever attempted to reduce its balance sheet on a scale the Federal Reserve is looking to do. And they are doing this when economic data is unclear, but this should not derail the economy or markets. Because the risk of a recession is low right now, Simply Money Advisors believes that stocks will continue to head higher over the coming months. So, you can view any short-term negative side effects on the stock market brought on by the Federal Reserve's plan to reduce its balance sheet as possible buying opportunities.