The Fed Effect: How Monetary Policy Impacts Your ETFs

Published on November 18, 2013 | Updated February 25, 2014

Since the unprecedented financial crisis of 2008, there is perhaps no bigger market mover than the Federal Reserve. The central bank’s unprecedented rounds of stimulus measures have subsequently made tremendous impacts on the market, sometimes dictating its every move. Whether it be a monetary policy change, an FOMC minutes release, a press conference, or even a “hint” from a Federal Reserve official, investors have kept a close eye on these events, clinging to every one of the central bank’s every word.

To see just how much the Federal Reserve impacts the markets, we take a look at the daily price changes of some of the biggest and most popular ETFs on the market, highlighting the market’s reaction on the days the central bank made headlines.

On January 22, 2008, the Federal Reserve made its biggest single cut in U.S. interest rates for more than two decades, lowering the rate from 4.25% to 3.5%.

In its statement, the Fed said “The committee took this action in view of a weakening of the economic outlook and increasing downside risks to growth. While strains in short-term funding markets have eased somewhat, broader financial market conditions have continued to deteriorate and credit has tightened further for some businesses and households. Moreover, incoming information indicates a deepening of the housing contraction as well as some softening in labor markets.”

In March of 2008, the Federal Reserve took dramatic action to avert a global financial crisis, backing the acquisition of investment firm Bear Stearns to J.P Morgan. The Fed also announced that it would extend its “discount window” to investment banks, and cut interest rates once again to 2.25%

In its statement, the Fed noted “Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.”

In November of 2008, the Fed unveiled its first unconventional stimulus package, which later would become known as Quantitative Easing (or QE).

In a joint statement with the Federal Reserve, Treasury Secretary Hank Paulson said “I wish, and I know everybody wishes, that one piece of legislation, and then magically the credit markets would unfreeze. That’s not the type of situation we’re dealing with.”

In March of 2009, the Fed announced that it would expand its quantitative easing program, pumping an extra $1 trillion into the markets by purchasing Treasuries and mortgage-backed securities.

In its statement the Fed said “In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability.”

After taking several unprecedented monetary policy actions in 2008, the Fed made a joint statement with the U.S. Treasury in March of 2009 to clearly spell out the roles of the Fed and Treasury as crisis managers.

The central bank stated “As long as unusual and exigent circumstances persist, the Federal Reserve will continue to use all its tools working closely and cooperatively with the Treasury and other agencies as needed to improve the functioning of credit markets, help prevent the failure of institutions that could cause systemic damage, and to foster the stabilization and repair of the financial system.”

In April of 2009, the Federal Reserve announced its agreement with the European Central Bank, the Bank of England, and the Bank of Japan to put in place swap arrangements that would enable the provision of foreign currency liquidity by the Federal Reserve to U.S. financial institutions.

In its statement, the Fed said “Should the need arise, euro, yen, sterling and Swiss francs would be provided to the Federal Reserve via these additional swap agreements with the relevant central banks.”

On March 31, 2010, the Fed’s QE1 officially ended, making investors understandably leery of the U.S.’s economic state. Many, however, thought that the Fed would be completely done with its asset purchase program, as the bond and stock markets were finally showing some signs of life. 

Commenting on the state of the markets during the time, future Fed Chairman nominee Janet Yellen said “Financial markets have improved considerably over the last year, and I am hopeful that mortgages will remain highly affordable even after our purchases cease. Any significant run-up in mortgage rates would create risks for a housing recovery.”

After the unprecedented first round of economic stimulus failed to meet all of the Fed’s goals, the central bank announced that it would launch yet another bond-buying program (known as QE2) in November of 2010.

In its statement, the Fed said “Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low…  Although the Committee anticipates a gradual return to higher levels of resource utilization in a context of price stability, progress toward its objectives has been disappointingly slow.”

On June 30, 2011, QE2 officially ended.  Unlike QE1, however, many economists and analysts were mixed on the prospects of further easing. 

Commenting on the effectiveness of QE2, Federal Reserve Bank of St. Louis President James Bullard noted “This experience shows that monetary policy can be eased aggressively even when the policy rate is near zero. The financial market effects of QE2 looked the same as if the FOMC had reduced the policy rate substantially. In particular, real interest rates declined, inflation expectations rose, the dollar depreciated, and equity prices rose. These are the ‘classic’ financial market effects one might observe when the Fed eases monetary policy in ordinary times.”

In August of 2011, the Fed gave somewhat of a gloomy outlook for the U.S. economy, and surprised Wall Street by hinting at further stimulus measures. The central bank indicated it would keep interests rates “exceptionally low” until at least mid-2013.

In its statement, the Fed said “Indicators suggest a deterioration in overall labor market conditions in recent months, and the unemployment rate has moved up.  Household spending has flattened out, investment in nonresidential structures is still weak, and the housing sector remains depressed,” adding, ” It [The Fed] will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.”

On September 21, 2011, the Federal Reserve announced “Operation Twist,” a stimulus measure last seen in the 1960s. Though the launch of Operation Twist was widely expected, analysts still questioned its effectiveness. 

In its statement, the Fed said “This program should put downward pressure on longer-term interest rates and help make broader financial conditions more accommodative.”

On January 25, 2012, the Fed took a historic step by announcing its longer-run goals and policy strategy, specifically stating its target inflation rate of 2%.

In its statement, the central bank said “Communicating this inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee’s ability to promote maximum employment in the face of significant economic disturbances.”

In June of 2012, the Fed announced that it would expand its Operation Twist program through the end of 2012, selling $267 billion of shorter-term securities and buying the same amount of longer-term debt in a bid to reduce borrowing costs and spur the economy.

Commenting on the central bank’s actions, Bernanke stated “If we don’t see continued improvement in the labor market, we’ll be prepared to take additional steps if appropriate. Additional asset purchases would be among the things that we would certainly consider.”

On September 13, 2012, the Fed announced its plans to launch its third round of quantitative easing (QE3), where the central bank would buy $40 billion a month in mortgage-backed securities.

Commenting on QE3, Bernanke stated “The employment situation, however, remains a grave concern. While the economy appears to be on a path of moderate recovery, it isn’t growing fast enough to make significant progress reducing the unemployment rate,” adding, “I want to be clear — While I think we can make a meaningful and significant contribution to reducing this problem, we can’t solve it. We don’t have tools that are strong enough to solve the unemployment problem.”

At the end of 2012, the Fed announced that it would continue its open-ended stimulus program and keep short-term interest rates near zero. The central bank also specified its inflation and unemployment rate targets, and until those goals have been reached, the Fed stated it would continue its easy money policies.

Commenting on the new targets, Bernanke stated “If we could wave a magic wand and get unemployment down to 5 percent tomorrow, obviously we would do that. But there are constraints in terms of the dynamics of the economy, in terms of the power of these tools and in terms that we do need to take into account other costs and risks that might be associated with a large expansion of our balance sheet.”

During a question-and-answer session with the Joint Economic Committee in Washington, Bernanke hinted that the U.S. central bank could slow down its asset purchase program in the next few months.

Bernanke noted “In the next few meetings, we could take a step down in our pace of purchase,” but warned, “A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.”

After Bernanke revealed the Fed’s plans to scale back its bond purchases in the coming months, investors subsequently panicked, fearing a taper could rock the markets.

In an effort to quell these fears, Dallas Fed President Richard Fisher stated his support of the central bank tapering its bond-buying program, but emphasized the need for the scale back to be a gradual process. Minneapolis Fed President Narayana Kocherlakota also voiced his support of the Fed, telling investors that the central bank has not become more hawkish.

In September of 2013, the Fed announced that it will continue its bond-buying program for at least another month, stating that it wanted to see more evidence that the economy can sustain improvement before scaling back its bond purchases.

Commenting on the Fed’s decision, Bernanke state “We could begin later this year, but even if we do that, the subsequent steps will be dependent on continued progress in the economy … So we are tied to the data. We don’t have a fixed calendar schedule.”

On October 30, 2013, the Fed stated that it would continue its easy-money program and gave no clear signal about whether they would begin tapering in the coming months.

In its FOMC statement, the central bank noted The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished, on net, since last fall… The Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.”

On December 18, 2013, the Federal Reserve announced that it would begin tapering its bond-buying program, reducing  its monthly bond buying by $10 billion starting in January.

In his final news conference as Fed Chairman, Bernanke commented “Today’s policy actions reflect the assessment that the economy is continuing to make progress, but that it also has much farther to travel before conditions can be judged normal.”