What the Federal Reserve Statement Will Mean for the Dow Jones

The Dow Jones Industrial Average (DJINDICES: ^DJI  )  is flat today as we are less than an hour away from the release of the Federal Open Market Committee statement. The Fed is expected to announce another $10 billion reduction of its monthly asset purchases. As of 1:25 p.m. EDT the Dow was up 23 points to 16,558. The S&P 500 (SNPINDEX: ^GSPC  ) was up two points to 1,881.

For the past few years, under various programs, the Federal Reserve has pursued a zero-interest-rate policy and bought billions of dollars in long-term assets each month in an effort to keep long-term interest rates down and spur on the housing market and economy. As a result, the Federal Reserve now has a balance sheet of $4.3 trillion of assets.

US Federal Reserve Total Assets Chart

US Federal Reserve Total Assets data by YCharts.

The Fed's asset purchases rose as high as $85 billion per month -- $40 billion worth of mortgage-backed securities and $45 billion in long-term Treasury bonds -- not including reinvestments. Starting in January of this year the Fed began "tapering" its purchases, reducing them so far at an average of $10 billion per meeting. As such, in April the Fed planned to purchase $55 billion of assets. The Fed is expected to continue its tapering in today's statement, though this morning's weak Q1 GDP report has some wondering whether the Fed will hold off for a month.

There were two U.S. economic releases today.

Report

Period

Result

Previous

ADP private-sector jobs

April

220,000

202,000

GDP growth

Q1

0.1%

2.6%

Economists expected weak GDP growth of just 1.1% in the first quarter, but it came in at a tenth of that at 0.1% growth. Investors should remember that this is only the first look at Q1 GDP; the report will be revised twice more in the coming months. The main takeaway is that weak GDP growth was largely the result of the terrible winter weather the U.S. experienced. ADP's private-sector jobs report, as well as recent purchasing managers' indexes, show that the jobs market is strengthening, which bodes well for the U.S. economy going forward. In the previous FOMC statement and in speeches since then, the Fed has blamed the poor economic data on the winter weather. I fully expect the Fed to announce another $10 billion taper this month.

The most important part of the FOMC statement will be the Fed's plans for interest rates. Interest rates affect the valuation of all other assets, and as short-term interest rates are effectively at zero, the stock market will look overvalued if interest rates rise to normal levels. It may still be a while before this happens; the Federal Reserve has a mandate to promote maximum employment and stable prices. However, in its last statement, the Fed said, "The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."

The market currently expects the Fed to start raising rates at some point in the second half of 2015. If growth stalls or something else happens to derail the Fed's plans, interest rates could remain low for longer, keeping asset prices high and real returns low.

Foolish bottom line
While I believe the stock market is overvalued, opinions differ. But with the Federal Reserve committed to low interest rates and pumping money into the economy, who knows how high the market can go? One thing is for sure: It's getting harder and harder to find great companies at good prices.

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