Last week, the Federal Reserve, the USA’s central bank, opted to lower the federal funds rate (the key interest rate controlled by it) by 50 basis points, or 0.5%. The move, both before and after it was announced, was heavily scrutinised by market participants. There’s a wide-held belief that the Federal Reserve wields tremendous influence over nearly all aspects of financial market activity in the USA.
But Aswath Damodaran, the famed finance professor from New York University, made an interesting observation in a recent blog post: The Federal Reserve actually does not have anywhere close to the level of influence over America’s financial markets as many market participants think.
In his post, Damodaran looked at the 249 calendar quarters from 1962 to 2024, classified them according to how the federal funds rate changed, and compared the changes to how various metrics in the US financial markets moved. There were 96 quarters in the period where the federal funds rate was raised, 132 quarters where it was cut, and 21 quarters where it was unchanged. Some examples of what he found:
- A median change of -0.01% in the 10-year Treasury rate was seen in the following quarter after the 96 quarters where the federal funds rate increased, whereas a median change of 0.07% was seen in the following quarter after the 132 quarters where the federal funds rate was lowered. Put another way, the 10-year Treasury rate has historically tended to (1) decrease when the federal funds rate increased, and (2) increase when the federal funds rate decreased. This means that the Federal Reserve has very little control over longer-term interest rates.
- A median change of -0.13% in the 15-year mortgage rate was seen in the following quarter after the quarters where the federal funds rate increased, whereas a median change of -0.06% was seen in the following quarter after the quarters where the federal funds rate was lowered. It turns out that the Federal Reserve also exerts little control over the types of interest rates that consumers directly interact with on a frequent basis.
- A median change of 2.85% in US stocks was seen in the following quarter after the quarters where the federal funds rate increased, a median change of 3.07% was seen in the following quarter after the quarters where the federal funds rate was lowered, and a median change of 5.52% was seen in the following quarter after the quarters where the federal funds rate was unchanged. When discussing the stock-market related data, Damodaran provided a provocative question and answer:
“At the risk of disagreeing with much of conventional wisdom, is it possible that the less activity there is on the part of the Fed, the better stocks do? I think so, and stock markets will be better served with fewer interviews and speeches from members of the FOMC and less political grandstanding (from senators, congresspeople and presidential candidates) on what the Federal Reserve should or should not do.”
I have always paid scant attention to what the Federal Reserve is doing when making my investing decisions. My view, born from observations of financial market history* and a desire to build a lasting investment strategy, is that business fundamentals trump macro-economics. Damodaran’s data lends further support for my stance to mostly ignore the Federal Reserve’s actions when I assess opportunities in the stock market.
*A great example can be found in Berkshire Hathaway, Warren Buffett’s investment conglomerate. Berkshire produced an 18.7% annual growth rate in its book value per share from 1965 to 2018, which drove a 20.5% annual increase in its stock price. Throughout those 53 years, Berkshire endured numerous macro worries, such as the Vietnam War, the Black Monday stock market crash, the “breaking” of the Bank of England, the Asian Financial Crisis, the bursting of the Dotcom Bubble, the Great Financial Crisis, Brexit, and the US-China trade war. Damodaran’s aforementioned blog post also showed that the federal funds rate moved from around 5% in the mid-1960s to more than 20% in the early-1980s and then to around 2.5% in 2018. And yet, an 18.7% input (Berkshire’s book value per share growth) still resulted in a 20.5% output (Berkshire’s stock price growth).
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