Chart 4. The Pace Of Tightening Will Be Crucial To Future Economic Growth

Higher Rates Unlikely Before June
Changes in interest rates can have far-reaching effects on the economy. Therefore, when and how fast Fed policy makers might increase benchmark rates is a subject of much debate. The Fed aims to inform the public of a likely policy change via carefully crafted official statements and press briefings collectively referred to as forward guidance.

Since December 2014, the central bank’s Federal Open Market Committee, or FOMC, which determines the stance of monetary policy, has stated that it can be “patient” before beginning to tighten credit. In a briefing that month, Fed Chair Janet Yellen said that the target range for the federal funds rate, the benchmark used in overnight lending between banks, was unlikely to be raised in at least the next couple of FOMC meetings after “patient” was removed from the forward guidance. At the time, observers took that to mean no increase was likely until the end of April 2015, two scheduled FOMC meetings later. Yellen essentially confirmed that interpretation.

In recent congressional testimony, Yellen stuck with the phrases “patient” and “for at least the next couple of FOMC meetings” when describing the trajectory of future interest rate increases. This implies that Fed policy most likely will remain unchanged until at least the middle of June 2015. Even though the FOMC did drop the patience promise in its March meeting statement, it doesn’t mean it is yet set on the timing for the first rate increase. 

Absent an unexpected and substantial improvement in the economy between now and June, it is unlikely that the Fed will raise rates before then. But, if improvements continue in the labor market and CPI increases begin to accelerate, higher rates become more likely in the second half of this year. As we noted in January, the more important questions regarding monetary policy are how rapidly tightening occurs and where it stops (Chart 4).

There are certainly benefits to be derived from higher interest rates. For one thing, savers and lower-risk investors will receive better returns. Also, once rates move away from the zero boundary, the Fed will have more flexibility to react to changing economic conditions.

On the other hand, tightening credit poses risks to growth. Raising rates too quickly or too much could push the economy into recession and increase volatility in financial markets.

Fiscal/regulatory Policy
New Rules For Brokers?
Recently President Barack Obama brought to the forefront proposed changes in rules governing broker-dealers who guide investments many Americans make with their retirement funds. The proposal would impose a fiduciary standard on these brokers, requiring them to act in their client’s best interest. The administration has directed the Department of Labor to start the rule-making process to implement the change, which may take months to complete.

Currently, two broad groups of investment professionals are governed by different standards. Registered investment advisers, who are in the business of providing advice about securities and may also manage clients’ investments, are subject to a fiduciary standard. So they are already required to act in the best interest of their clients. Brokers (or broker-dealers), who buy and sell securities on behalf of clients and may provide investment advice, are governed by a less strict standard. Under it, the investment options brokers suggest must be suitable for the client, taking into account factors such as age, income, net worth and investment goals. 

This leaves open the possibility that a broker might recommend investment products that pay him or his firm higher fees or commissions but which may not be in the best interest of clients. Over the long-term, even small differences in fees and expenses can lead to noticeably lower realized returns to investors. The conflicted advice costs American savers an estimated $17 billion a year in forgone investment returns, according to the president’s Council of Economic Advisers, or CEA. Eliminating such conflicts is the thrust of the administration’s push for the stricter fiduciary standard for brokers.

Some in the financial industry claim that implementing stricter standards may lead to negative consequences. With stricter standards it becomes costlier (and riskier) for brokers to give any sort of investment advice to clients. That may lead some to stop offering advice altogether, especially to clients with smaller accounts. Brokers who wish to continue advising investors may have to become registered financial advisers and raise prices for their services. Also, brokers may become reluctant to offer certain investment products to clients for fear of violating the fiduciary standard. Critics of the proposal say that ultimately it will limit investment options for smaller investors and reduce their access to investment advice.

The stakes involved are substantial. More than 40 million American families have individual retirement accounts with savings totaling more than $7 trillion, according to the CEA. While it is difficult to know which of these accounts are managed by brokers as opposed to registered investment advisers, the number likely runs into many millions. Changing the rules governing the interaction of brokers and their clients will affect millions of American families. The intent of the rule change is to improve the quality of financial advice given to less sophisticated investors and to enhance their returns.

Next/Previous Section:
1. Overview
2. Economy
3. Inflation
4. Policy
5. Investing
6. Pulling It All Together/Appendix