THE FED JUST FLIPPED | Major Changes Explained

What's up you guys, it's Graham here.

So throughout the last month, there have been non-stop headlines about how the Federal Reserve is crashing the market, and in a way, they kind of did. January of 2022 quickly became the worst month on record ever for the S&P 500, having dropped 11%, as investors braced for the possibility that the Fed was going to raise interest rates, cut stimulus, and do anything they can to curb inflation, which has risen above 7% for the first time in 40 years.

However, the key moment that we have all been waiting for is here. So without further ado, almost every single fear throughout the last 12 months has been kind of answered in terms of whether or not the Federal Reserve is raising rates, when they plan to do so, and if that means the market is going to turn back around, making us all a whole bunch of money, or if it's going to continue selling off like it just did. All of that and more on this episode of "The Market Makes Absolutely No Sense," and as soon as it turns green, it goes back to red. So make sure to smash the like button and subscribe to hear about these new Federal Reserve changes that will impact you, your money, and the market.

All right, first it's important that we mention what the Federal Reserve actually does, because unlike what most people think, their job is not to make the stock market go up. So with that out of the way, the Federal Reserve is what's known as a central bank, whose role is to oversee our economy, regulate financial institutions, and control the supply of money that goes into and out of our economy.

Their priority over everything else is to make sure that the US has a strong labor market, has reached maximum levels of employment, and to keep inflation under control, so that we're not paying $50 for a loaf of bread by 2030. Because of that, they're one of the most influential entities throughout our economy, and their policy changes have the power to move markets either way with a single remark.

So in terms of what's happening now, we first have to understand what happened back in March of 2020, because I promised that's going to tie everything together. Back then, there was a serious concern that our entire economy would collapse from being shut down, lending would freeze, businesses would fail, and people would be left to fend for themselves while the markets just turned red. So the Fed took action ahead of time by lowering interest rates down to 0% to incentivize people to spend and borrow more money.

However, a side effect of doing this is, you guessed it, high inflation and high asset values. So now it's the Fed's job to slow things down before they get too out of control. In terms of how they plan to do this, that information was just revealed a few hours ago, and this is what's going on with the market.

First, we have what's known as the Fed taper. Up until last month, the Federal Reserve was purchasing $120 billion a month of treasuries and mortgage-backed securities to ensure that whoever needs money got it. But that was only meant to be temporary, and lately, the entire market began selling off in the fear that they would reduce these purchases a lot faster than expected. However, with this new announcement as of a few hours ago, the Federal Reserve confirmed their plan to reduce their stimulus by $30 billion each month until by the end of March, they're completely done and don't need to buy anything else.

The plan is by reducing these asset purchases a little bit at a time, the market will begin to function on its own. Even though there might be some adjustment along the way, the goal is that we should barely even notice it. But that was only the very beginning, and in terms of why the market began to sell off, here's what we need to focus on.

Second, we have upcoming interest rate hikes. Like I mentioned, throughout the last 18 months, interest rates have pretty much been zero. But as we all know, these conditions can't last indefinitely. There are only so low that rates could go before inflation gets out of control; borrowing has been maximized and becomes counterproductive. So, as a result, a rate hike is in order.

However, the market didn't know exactly when this was going to happen or how much of a rate increase would occur. So when people are left to their own devices, they tend to panic. In fact, there was so much uncertainty that the stock market sold off on the chance that we would see more than four rate hikes throughout 2022. Under this new announcement, however, the Fed said that the committee decided to keep the target range for the federal funds rate at 0 to a quarter of a percent. In other words, this means that the Fed is not going to be raising interest rates more than expected; they're airing on the side of caution and keeping rates low until they're confident that they could raise them without causing us all to go into a recession.

But that doesn't mean that multiple rate hikes can't happen throughout 2022. And when Dr. Powell was asked whether or not we could see a larger rate hike than expected, he explained that since our economy is growing faster than expected, it's not out of the question, which brings us to the deal breaker that sent our markets back down.

All right, so now let's talk about the third piece of information that sent our markets back down into a spiral of red, and that would be more inflation to start. As I'm sure we're all aware, inflation is everywhere and it's a lot higher than expected for two reasons. One, we have supply chain bottlenecks and high shipping costs. For example, due to a backlog of supply, shipping container costs are expected to rise by an average of 126% this year.

Even worse, spot rates of current shipments are four and a half times higher than a year ago. And two, there's an ongoing labor shortage that means with fewer workers, companies have to pay more to attract new talent, and that extra cost in turn gets passed on to you as the customer in the form of higher prices. In fact, 63% of small businesses have already bumped up the prices of products and services in the last year to compete.

On top of that, a labor shortage also means that there are fewer people capable of handling a high inventory of shipments coming into the ports. That's created a traffic jam of cargo vessels waiting weeks at sea to dock, further delaying their arrival and costing significantly more money to operate.

So all of that is to say that today the Fed made the statement that supply and demand imbalances related to the pandemic and the reopening of our economy have continued to contribute to elevated levels of inflation, in which they expect progress to be made in solving these issues throughout the next year.

However, even though less inflation would mean less of a reason to raise rates and less of a reason to panic, when asked about their current stance, they mentioned that since the December meeting, I would say that the inflation situation is about the same but probably slightly worse, signaling that perhaps there's a stronger chance of raising rates than we think. They also reiterated that the committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that would impede the attainment of the committee's goals.

Or more simply put, if anything happens, they would be able to change the course and keep the money printer going just a little bit longer. But remember, this is not the first time that the Fed has ever raised rates, and if we look back in the past, here's what you need to know.

First, we could look at the mortgage crisis of 2009, where the Fed did something eerily similar to what we're seeing today. After the housing market crash, they wound up buying mortgage-backed securities as a way to stimulate lending and get the economy back on its feet. But in 2013, it was announced that they would begin to think about raising rates, and with that one comment, the market began to sell off. Investors suddenly stopped buying mortgage-backed securities, interest rates spiked out of nowhere, volatility went crazy, emerging markets tumbled, and the thought was that this was the beginning of the end.

However, much of that proved to be an overreaction because the Fed didn't actually start to raise rates when they said that they would think about raising rates, and within a short time after, things were back to normal. Until 2018, this is the point where the economy was growing at a consistent rate, unemployment was low, and the Federal Reserve began raising interest rates back to historically neutral levels without stifling the growing economy.

But as a result, the stock market posted its worst year in a decade, as the S&P 500 fell 20% from September 2018 to January 2019. At the time, investors felt like the Fed was making a big mistake and that raising rates would lead to an economic downturn. But just as the markets were beginning to enter a bear market, the Fed stepped in and said, "Hey guys, actually we're going to raise rates a little bit slower than expected, uh, our bad." And just six months later, they did the unthinkable and actually lowered rates for the first time since 2008, causing, of course, the market to resume its upward trend.

So now, in terms of what's going on today, here's what you got to know. Overall, the market began to sell off on the fear that since our economy is strong, since unemployment is low, and since inflation is high, the Federal Reserve has more room to raise interest rates faster than expected without threatening the labor market.

Even though they say they're going to take their time to do so, since they mentioned that inflation in December is about the same but probably worse, that signals that they're more likely to raise rates to dampen prices, which in turn causes the market to sell off because there's no definitive time frame on exactly when this was going to happen or if the possibility of a half a point increase is off the table.

That leaves investors to price in the worst possible case scenario, and that's why the market began to sell. It's really important to realize that in these situations, the Federal Reserve is not catering to the stock market, and they don't care how much the S&P moves down from their decisions. Their priority is inflation and the labor market.

If they could get inflation down to 2% while maximizing the number of people that are employed, they'll succeed. So from that perspective, even though it's really important to understand what's going on, it's not Jerome Powell's job to keep your account from going down into the red. Instead, I would use these times of uncertainty to continue to buy into the markets as normal and recognize that no one has any clue what's going to happen.

The fact that the market was up 2.5% this morning and then closed down goes to show you that these day-to-day movements are trivial and that long-term, the best thing that we could do is buy as normal. Enjoy the discounts while they last, be prepared that things could always get a little bit worse, and no matter what, smash the like button for the YouTube algorithm.

So with that said, guys, thank you so much for watching. Also, make sure to subscribe. Feel free to add me on Instagram and on my second channel, "The Graham Stephan Show." I post there every single day I'm not posting here, so if you want to see a brand new video from me every single day, make sure to add yourself to that. Thank you so much for watching and till next time!