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Advisors Can Provide a Steady Hand Amid Fed Uncertainty

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Advisors could soon find themselves trying to calm clients' frayed nerves thanks to a series of looming decisions and debates coming out of Washington.

One of those questions is the specter of an interest-rate hike from the Federal Reserve, which for months has been indicating that it intends to elevate rates up from the near-zero level that's held steady since late 2008 when the economy teetered on the brink of collapse.

Trying to divine the future of interest rates is a favorite parlor game among economists and financial professionals, and Fed officials have been sending mixed signals about what course they might take when they meets later this month.

But given the recent market turmoil and the continued uncertainty about the stability of the Chinese economy, a lower than desired rate of inflation and a number of other factors, a panel of former Fed officials believe that the rate hike won't likely come until the end of this year, at the earliest.

And while the Fed under Chair Janet Yellen has insisted that it will act in a data-driven fashion, officials are sensitive to market conditions, and would likely not be eager to opt for a rate increase in September when many in the investing community have become convinced that rates will hold low for the time being, according to Julia Coronado, chief economist at the hedge fund Graham Capital Management and a former economist at the Federal Reserve Board of Governors.

"It would be a very big surprise for the markets if they actually raised rates [in September]," Coronado said at a recent panel discussion on the Fed hosted by the Brookings Institution, a Washington think tank. "And the Fed would not want to surprise markets."

Coronado and others take a dim view the prospect of a September rate increase, and she pegs the chances that the Fed will act at all this year only at about 50-50. In light of the new custom of the chair giving a quarterly press conference to discuss the Fed's latest thinking, observers suggest that the earliest rate move would be December.

The panelists said that the best approach for the Fed is to make its decision based on the direction the economy appears to be headed in the near term, but still looking out several quarters rather than just focusing on any one economic indicator or set of immediate data points.

"I have to think about where we're going to be in one to three years," says Donald Kohn, a senior fellow at Brookings who spent four decades at the Fed, culminating in a stint as vice chairman of the Board of Governors. "I like to think of the Fed's decisions as being outlook-dependent."

Coronado also notes that the Fed, beginning under Ben Bernanke and extending through Yellen's chairmanship, has become consumed by its role in shepherding along the economic recovery. As such, it appears to view its role in monetary policy against the backdrop of preserving market stability and prosperity. This, in turn, may be a signal that any rate increase will only come gradually, with ample warning, and will follow a period of relative stability -- hardly the conditions that have characterized the run-up to the September meeting.

"I think there's an important element of Fed policy that's always been there that we aren't talking about in our one to three year [outlook] -- and that is risk management," Coronado says. "The Fed has cultivated this recovery so carefully, with such enormous effort, for the last seven years. Are you really going to take the risk in this environment with unstable global financial markets with real macroeconomic questions about the global outlook that are not just about volatility?"

"What central bank would raise rates after a massive -- I would say -- shock to global financial markets? At least sizable, maybe not massive. And the world didn't fall apart, but it's a pretty big shock and a pretty big rumble that you've got to take seriously," she adds.


The Fed's action -- or inaction -- on interest rates, is only one of the upcoming policy areas that advisors should be watching.

Andy Friedman, publisher of the Washington Update, says one of the first orders of business when Congress returns to session will be the annual battle over funding the government. This is something the markets take notice of when it threatens a government shutdown, as occurred two years ago, and may again this year.

"I'm concerned we could be looking at a reprise of 2013," Friedman warns, noting that Planned Parenthood could be the target of congressional Republicans this time around.

Friedman notes, however, that the appropriations battle with its Oct. 1 deadline won't come paired with the need to increase the government's borrowing cap this year, although the debt ceiling could be reached in November or December.

Advisors should feel confident reassuring their clients that lawmakers will reach a resolution, just as they always do, but quite possibly not before sending Wall Street on a roller-coaster ride, and in the process creating a potential opportunity for investors.

"Historically, markets often are volatile as fiscal deadlines approach and Congress appears unable to agree on a solution -- until it does." Friedman says. "Investors might consider taking action to protect against volatility until these deadlines have been addressed. More aggressive investors might view a pullback as a buying opportunity -- markets tend to recover nicely after Congress finally agrees to raise the nation's borrowing limit (as Congress invariably will do here, likely at the last possible moment)."

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