Don’t Fight the Fed! (Especially in a Pandemic)

Liz Kesselman:

In this Adviser You Can Talk To Podcast, we’ll be talking about the Federal Reserve. Can the Fed save the world? Will it be able to help inoculate the markets from the toll of COVID-19? Join me, Liz Kesselman, alongside Jim Lowell, Adviser Investments’ Chief Investment Officer, for an insightful conversation.

Liz Kesselman:

Hello, I’m Liz Kesselman. I’m a Vice President here at Adviser Investments, and I’m here today with another Adviser You Can Talk To Podcast. I’m joined by Jim Lowell, our Chief Investment Officer, and a great student of history. Today, Jim, we’re going to talk about the Federal Reserve, specifically, can the Fed save the world and will it be able to help inoculate the markets from the toll of COVID-19?

Liz Kesselman:

So we’ve got a great topic here. I think we’ll jump right in. Why don’t we start by doing a quick primer on the Federal Reserve, also known as the Fed. What are the key functions of the Fed? Can you talk a little bit about that to get us started?

Jim Lowell:

Liz, first, kudos to you for making the Fed sound interesting, right? [laughter]. Look, most people think of the Fed as the Great Oz behind the curtains. It’s very difficult to know what the Fed actually does. So you’re right. Let’s start with defining who they are and what they’re supposed to be doing. I mean, effectively, the Federal Reserve, which was created in 1913, is what we call the central bank of the U.S. By that mandate, it performs, I would say five key functions that ultimately combine to promote, hopefully, a smooth running U.S. economy. Of course, in times of crisis, the Fed is part and parcel of not just the daily headlines but also the solution. So I look forward to talking about the ways in which the Fed has been moving.

Jim Lowell:

But in terms of those five general functions, the first one, it’s a clear mandate to provide what we call monetary policy, so cash flow, that promotes maximum employment and stable prices, which is a economic synonym for low inflation, and also provide what are considered to be moderate long-term interest rates in the U.S. economy. That mandate is specific to their charge in terms of safeguarding the consumer. They also try to maintain the stability of our overall financial system. And as they have done since 1913, sometimes successfully, sometimes unsuccessfully, they try to minimize and contain systemic risks to our financial system. They do that by means of their regulatory vigilance, actively monitoring, sometimes directly engaging in the U.S. and global banking system.

Jim Lowell:

They also are mandated to safeguard the soundness of individual financial institutions, mainly banks here in the U.S.. So they monitor those as well, and they do that with two ends in mind. The first is to make sure that the individual banks’ potential impact on the overall financial system, couldn’t break the overall financial system, and the second is to monitor the overall financial system. And then, let’s see, I think I’m down to the fourth principle—to effectively maintain what I would call sort of a bank of and for our banks; in other words, a settlement place, a liquidity system for the banking industry.

Jim Lowell:

And then the fifth, which really ties them all together, and I mentioned it in relationship to the first, is that they are always trying to, and supposed to, actively promote what I would call consumer protection and community development themes within everything that they do. Given that if they do their job well and consistently well, then the Fed actually ends up providing the necessary stability in a world that’s always prone to chaos for our economy to be able to grow reasonably well over any measurable time period. So those would be the five principles that drive the Fed.

Liz Kesselman:

Well, thank you. That’s a great overview. Obviously, you can tell from your comments that they’re extremely comprehensive and far-reaching. For the benefit of our clients and friends listening to this podcast, could you talk a little bit about—and I think this will go back to sort of number one, with maximum employment and the interest rate situation—how might our clients feel the impacts of what the Fed does in their own lives?

Jim Lowell:

They feel it most acutely when what the Fed does doesn’t work. You don’t have to go back to the depression of the late twenties, early thirties, but just go back to ’08, ’09 when things were breaking down, that sent the financial system into chaos, which sent our consumer-driven economy into recession swiftly and steeply. So when the Fed fails to provide for a safe and sound financial system, we basically immediately can see that it’s the bedrock of not just our economy and our markets, but the global economy and the global market too.

Jim Lowell:

So, one of the ways in which we can feel the impact function of the Fed is when what they do is not working all that well. However, the flip side of that, and certainly in ’08, ’09 this would be true, when we clearly put the theory of a systemic U.S. financial systems collapse to an actual real world test, we saw the Fed create what’s known as a quantitative easing, QE, flooding the market with liquidity in order to try and right the ships that were literally turning over in the harbor, safeguard our economy and markets and bring us back onto a road of recovery, which in fact they did. And that recovery, by the way, lasted for a historically notable time period of greater than a decade until COVID-19 struck-

Liz Kesselman:

Recently. Right. Right.

Jim Lowell:

So, the Fed jumping in, providing liquidity, driving interest rates low meant not only that people could begin to stabilize and recover. But as we climbed out, they maintained those low interest rates, which have a wonderful effect in terms of dampening down low mortgage rates, but also it provides greater purchasing power for every dollar in our wallet. So, quite literally, the Fed in ’08, ’09 did save, not just our world, but the world. Now, the ramifications of that liquidity—and we’re seeing it again. We’re now in what I would call QE to infinity. The ramifications of that may play out negatively a decade, two decades, three decades from now. In the midst of the crisis, it strikes me that they did the right thing in ’08, ’09. We now know that in hindsight and are likely doing the right thing even as we speak.

Liz Kesselman:

So the Fed a little over a hundred years ago came into being. What was it really that led for the creation of the Fed? You were talking earlier about regulating and interbank lending. Can you talk a little bit about the situation that we might have gotten ourselves into if the Fed wasn’t in existence?

Jim Lowell:

So the country was growing up and the states were growing up, and there was a need for interstate commerce, interstate banking and hence interstate regulation of banking and commerce. And so, in 1913 it was deemed necessary, rightly so, to begin to build a regulatory body to ensure a relatively smooth, and back then much less, but nevertheless, still relatively transparent overall financial system for our economy. Of course, that Fed’s test came fairly swiftly.

Jim Lowell:

In the 1920s, the Fed was really very loose with monetary policy, effectively printing money, which led to inflation, which led to the Roaring Twenties, which clearly led to what’s known as the Great Depression. Something that my grandparents on both sides of my family lived through and that I had to listen to across the dinner table endlessly, waste not, want not, and was a core theme in my family. What happened in the Great Depression, many economists think that the Fed’s overreaction to loose monetary supply by dramatically tightening it and keeping their grip on money tight for years actually prolonged the depression and worsened its toll.

Jim Lowell:

So, flash forward to ’08, Ben Bernanke, a student of Fed history-

Liz Kesselman:

Sure.

Jim Lowell:

… par excellence, I mean, a dedicated student, understood what had happened during the depression, or at least had his view on why the Fed’s move to tightening was problematic and went the other direction. And, as we know—at least in the short term, because history of course spans centuries, not just a decade—but at least in the short term, we know that what the Fed did in ’08, ’09, having learned that lesson of tight monetary policy in the Great Depression, help stave off another one.

Liz Kesselman:

Ah, so that’s a good segue, because I wanted you to walk us through past lessons and what the Fed has done in the past versus what the Fed’s doing now. There has been so much going on since the middle of March, I think it’s difficult to keep up with. So I was hoping you could just talk a little bit about the tools the Fed has put in place now, and then just perhaps you could work in… I hear from some folks that they are concerned that the Fed might be actually running out of tools, that the playbook has been played. So perhaps you could talk a little bit about that theme of what did we do in ’08, ’09 and what the Fed is doing now, just as sort of, again, a bit of a primer because I think there’s been a lot of information flow and it’s confusing.

Jim Lowell:

You’re absolutely right. There’s been a tsunami of information, especially since March 23rd when the market hit its low. And a lot of it relates to theories on whether or not what the Fed and the global equivalents to our Fed are doing and whether or not their cure is going to ultimately kill the patient. My view is that the Fed today clearly is taking a page from the ‘08-‘09 playbook, but dramatically increasing it, given the scope and scale of the COVID-19 toll. In the Great Depression, people still went out to dinner. People still traveled. In ’08, ’09, people still went out to dinner, to sporting events, still traveled, still were buying homes, still were furnishing their homes. They weren’t locked out and locked down from being able to do so.

Jim Lowell:

So, if you flashback to March, the world was literally forced to come to a standstill. That had never happened before in terms of the global economy, not through great world wars, not through depressions. So, the Fed, I think, immediately and very swiftly, and at least in terms of the crisis in which we’re still in, I think correctly moved and moved to dramatically lower interest rates, bringing them all the way down to near zero, in order to effectively safeguard liquidity in the market. They were doing things like bond buybacks, stimulus programs that they learned from in ’08, ’09. They were in direct conversations and trying to make concerted efforts with their global equivalents in the EU, around the globe, China and across Asia.

Jim Lowell:

There has never been, I don’t think, a moment like these last three months where the Fed has been working 24/7 to safeguard, not just our economy, but the global one. And literally as goes our economy, so goes the global economy. And so, all eyes have been on the Fed. So far, I think they are doing what needs to be done in the crisis. The flip side of it is whether or not the crisis worsens, and if it does worsen, have they run out of ammunition? No, they absolutely have not run out of ammunition. In a certain sense, they can’t because they can print money.

Liz Kesselman:

True.

Jim Lowell:

Does the flip side of printing money have the negative potentiality of hyperinflation, something that the Weimar Republic in Germany saw coming out of the depression of the thirties? Absolutely so, but that’s a fight we can fight down the road. Right now, the Fed is fighting with the dragon that’s in front of it as they should do. They also can institute innumerable stimulus measures in terms of buybacks. They can also help promote their global equivalents doing the same, which takes some of the burden off of their shoulders.

Jim Lowell:

So, overall, I think that there’s the expression, “Don’t fight the Fed,” which means that when the Fed is pumping money into the system, you don’t want to be overly bearish. We agree with that, but we also know that the Fed is taking these unprecedented actions because it sees things to be fearful of, not just in the rear-view mirror, but through the windshield. And we do too, and so we are going to remain disciplined and diversified in terms of our asset allocation, stocks, bonds and cash, in order to be able to wend our way through what is likely to still be some more difficult times to come, even if we get a reprieve during the summer.

Liz Kesselman:

Why do you think the Fed’s been more visible? I wanted to have this conversation today because I’m aware of how much more frequently I’m actually even talking about the Fed with clients. Why do you think—Is it the transparency? Do you think it’s a sort of Powell? What do you think?

Jim Lowell:

That’s a really good question, Liz. I can say that when Dan and I started in this business three decades ago, we would wait with bated breath to try and figure out the width and the weight of Chair Greenspan’s briefcase as a tell whether he was more worried about the economy, and those images would come out randomly.

Liz Kesselman:

Oh, that’s funny

Jim Lowell:

Look, everything’s become a media circus. But the Fed, I think, has done a very good job of staying away from the political ring and really only waiting into the economic and tangentially the markets ring. And this Fed chair, Chair Powell made the decision before COVID-19 to be even more transparent than the prior two Fed [Chairs] in terms of having a live press conference every time the FOMC meets rather than just eight times a year. So just by a function of that, the Fed would be in the news more often than not. And then in the times of a financial crisis, look, you look at the subscription rates to things like the New York Times, you look at viewer run rates on CNBC or Bloomberg, elsewhere, they tend to rise in times of crisis.

Jim Lowell:

It reminds me of an old Punch cartoon where you had a newsletter editor looking very glum, sitting at his desk in one frame, then news breaks over the wire that a ship has sunk, and then you see him dancing on the top of his desk in the third frame. The media loves a crisis and they love to feed that crisis, because it feeds them. But it doesn’t feed the Fed’s thinking. It certainly doesn’t feed into the Fed’s independent view of what their mandates are meant to, not just be, but how they are going to translate them into the real world regardless of who the president is, what the election cycle is. The Fed is focused on safeguarding the economy, and in doing so safeguarding our markets. And I think whether you like or loathe them, since ’08-’09, and certainly since March 23rd of this year, we can all be, I think, collectively thankful that that is their focus.

Liz Kesselman:

Right. So the Fed, to be clear, is not controlled by the president?

Jim Lowell:

Not in any way shape or form, although it’s an awfully interesting sort of cocktail conversation. Although I would say my recommendation for the summer is talk about everything, but politics. It’s become too rabid. But in terms of the Fed, no. The Fed is an independent body. They’re high-minded people. They know that their cause is greater than the election cycle of an individual.

Liz Kesselman:

Well, today’s media definitely likes catchy headlines. And we all know that bad news sells, so that is one adage that’s never changed. But, yes, I like the transparency. I think we all applaud the more frequent and open communication from the Fed. It’s just that more visibility doesn’t necessarily mean something negative. It’s just obviously more talking points, more data points. As you said, we are very encouraged by what the Fed is doing and are cautiously optimistic. So thank you for your perspective. I appreciate it.

Liz Kesselman:

Again, this has been Liz Kesselman and Jim Lowell from Adviser Investments. Thank you for joining us for The Adviser You Can Talk To Podcast. We hope you enjoyed this conversation and found it helpful. Please do subscribe and review our show. You can also check us out at Adviserinvestments.com/feedback, and if there’s any topics you’d like to hear, please get in touch with any of us here at Adviser. We’d be definitely interested in covering some more meaty topics in the future. Thanks again.