Aswath Damodaran: Fed Up With FED Talk

In this article and video, NYU professor Aswath Damodaran makes the data-driven case that the Federal Reserve’s influence over interest rates, the economy, and financial markets is far more limited than conventional wisdom suggests.

Here are the key take-aways:

• The Federal Reserve does not actually set most interest rates that consumers and businesses face, such as mortgage rates, credit card rates, or corporate bond rates. The Fed only directly controls the Fed Funds rate.

• Changes in the Fed Funds rate does not lead or drive changes in market interest rates like Treasury yields. Analysis shows little difference in Treasury rate movements following Fed rate changes.

• The signals sent by the Fed’s actions are often ambiguous and open to interpretation. For example, the recent 0.50% rate cut could be seen as a sign of lower inflation, slowing economic growth, or political motivations.

• Outside of crisis situations, the Fed’s impact on stock market returns is unclear. Data shows no significant difference in stock returns following Fed rate changes.

• The perception of the Fed’s power over the economy and markets has grown to unhealthy levels. In reality, the Fed is more of a follower than a leader and does not have the ability to override economic fundamentals. Attributing too much influence on the Fed distracts from more important economic issues.