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Stocks Tread Water As Investors Wait for the Fed

By Dan Caplinger - Mar 16, 2016 at 11:36AM

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A key decision on interest rates will have a big impact on the stock market.

The stock market has taken investors on a roller-coaster ride in 2016, and concerns about the health of the U.S. economy have played a key role in the ups and downs stocks have experienced so far this year.

Stocks started out with minimal movements on Wednesday, with the Dow Jones Industrials (^DJI 0.27%) (DJINDICES:$INDU) up just 12 points, or 0.08%, as of 11 a.m. ET. The broader S&P 500 (^GSPC -0.07%) posted a similar gain of about 0.1%.

Federal Reserve. Image source: Dan Smith.

Watching the Fed
One of the reasons this week has been less volatile than what investors have seen recently is that the Federal Reserve will conclude its two-day meeting on monetary policy on Wednesday afternoon. The U.S. central bank became the focus of investor attention in December, when it chose to increase short-term interest rates for the first time since 2006.

At the time, those who watch the Fed interpreted the move as a signal of the central bank's confidence in the strength of the U.S. economy, which had shown greater strength than most economies throughout the rest of the world for several years. The Fed came into December's meeting having established a long history of unprecedented efforts to stimulate the economy, including an extended period of near-zero interest rates and extensive purchases of financial assets to keep both short-term and long-term interest rates at low levels.

What's ahead for the market
The Fed's December decision answered the key question of when the central bank would start to push monetary policy back toward more normal conditions. However, it left unanswered the equally important question of how quickly future moves would occur.

The turbulence in the markets over the past three months created disagreements among Fed watchers about the answer to that second question. Some interpreted the Fed's December move as implying that future interest rate increases in a regular pattern, and one of the more popular theories was that the Fed would raise rates on a roughly quarterly basis, suggesting the Fed would make a second rate increase announcement this afternoon, after its meeting ends.

Others have noted the weakness in the global economy outside the U.S. as warranting a more cautious approach toward further rate increase from the Fed. The European Central Bank recently took steps to reduce its key short-term interest rates, pushing targets further into negative territory. Most national economies around the world remain under substantial pressure that is holding back growth, and the efforts they are making to stimulate greater economic activity stand in stark contrast to a U.S. central bank that appears to be in rate-tightening mode.

That debate makes the Fed's decision today extremely important for investors. If the Fed raises rates, it will establish a pattern that will lead investors to conclude that the central bank's primary concern is to get the U.S. economy back to a position where it isn't relying on artificial supports for growth. That could give investors more confidence in the strength of the economy, but it would also have an immediate impact on interest rate expectations for lenders and borrowers.

If the Fed keeps rates steady, however, it will lead to a reassessment of just how quickly future rate increases might occur. Moreover, by communicating uncertainty about the potential impact of foreign economic struggles on U.S. growth, the Fed might unwittingly create concern that would lead to further stock market volatility.

Either way, the Fed's decision will be an important one for investors. By examining both the decision itself and Fed Chair Janet Yellen's rationale for it, investors should be able to get a better sense of what lies ahead for the economy and the stock market.

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Dow Jones Industrial Average (Price Return) Stock Quote
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