Blog : The Coming Fed Policy Shift

by Ed Zwirn on November 6th, 2013

Research papers recently published by two senior U.S. Federal Reserve economists may prove to be the opening salvo for a change of monetary policy set to commence when Janet Yellen takes over in January.

Currently, the Fed is operating under rules, which I detail in an earlier penny stock blog, that effectively say it will not even begin to consider raising short-term interest rates from their current near-zero level until either unemployment falls to 6.5% (from its current 7.2%) or inflation rises to 2.5%.

Since neither of these is likely to happen over the next couple of months, investors have been understandably preoccupied by the timing of any "tapering" of the Fed's quantitative easing program, which pumps $85 billion monthly into the economy and will almost definitely end much sooner that the stimulus resulting from low rates.

But key members of the Fed analytical team are now arguing for a much longer-lasting stimulus. William English, director of the monetary affairs division and secretary and economist of the Fed's governing FOMC, and David Wilcox, an FOMC economist who heads the research and statistics division, have published near-simultaneous working papers arguing for both a raising of the Fed's inflation target and a lowering (to 6%) of the unemployment rate threshold.

Both of these papers are to be officially presented at the International Monetary Fund's annual research conference, which starts Thursday.

This proposal, if incorporated into Fed policy, would bring two major changes: 1) Prolonged monetary stimulus, benefiting everything from penny stocks to blue chips, as interest rates stay low for longer, and 2) Give the Fed a graceful out from its bond buying program.

According to a newly emerging consensus, the thinking unveiled by English and Wilcox, which dovetail's nicely with Yellen's stated views on the need to use monetary policy to fight unemployment, will be put into action by March, and could possibly be preceded by a "tapering" announcement before that.

This would in fact net out to good news for the stock market. The start of tapering at some point between now and June has already been priced into market expectations, but the extension of the more usual form of Fed stimulus (low interest rates) would prove to be a support for the market for penny stocks and other speculative investments, a support that may in fact last much longer than most people expected a short while ago.