By Thomas Kostigen
The Federal Reserve Board came out this month with a report that warned of global financial stability disruption being driven by climate change. It was the first time the Fed, as it’s known, address climate risks in such an alarming way, and it recommended more oversight and monitoring of the issue to the financial institutions that it oversees.
The warning may be outside the realm of how many view the Fed: as controller of monetary policy, responsible for keeping in check inflation and, in turn, the capital markets. The totality of risks it considers are often left behind for the more singular macroeconomic analysis it provides. The risks related to climate change have obviously risen high on the Fed’s agenda of economic policy to warrant such a stark report to the banks it oversees.
“It is vitally important to move from the recognition that climate change poses significant financial stability risks to the stage where the quantitative implications of those risks are appropriately assessed and addressed,” said Lael Brainard, a member of the Federal Reserve Board of Governors in a statement accompanying the Fed’s climate risk report.
The Fed acts as the central bank of the United States and is the keeper of the financial system. Its main function is setting interest rates that, in turn, affect how the economy operates, promoting employment and influencing prices. Yet it also—both directly and indirectly—promotes consumer protection and community development. It looks at emerging consumer issues and trends, community economic development activities, and the administration of consumer laws and regulations. It’s within these measures that investors can do some research to figure which sectors may be best avoided or susceptible to financial risk.
When the Fed sets interests rates, it affects the institutions who borrow from it. Higher interest rates typically mean inflation and lower stock market prices. Lower interest rates are typically indicative of a strategy to fight higher prices, or inflation; a way to engender lending and economic stimulus. That’s why when the Fed chairman announces rate adjustments, the financial markets wait with baited breath and look for signals in one direction or the other: it can mean buy, buy, buy, or sell, sell, sell. Bond markets, of course, are most directly affected by interest rates because yields and prices are part and parcel of their financial construction. The economic ramifications spill out from the debt to the equity markets.
Financial advisors can best figure Fed action—and potential action—on retirement accounts, trading accounts, as well as savings plans. This arguably becomes more important with older clients who becomes more focused on risk aversion than capital appreciation, and whose portfolios likely shift to emphasize more bonds than stocks. The incoming Biden administration, of course, will set a new Fed tone. Will interest rates rise or remain low? That will be the question on every financial professional’s mind.
The Fed’s report on climate change is an interesting tell about risk and where investors should be eying vulnerabilities. Other social issue effects on the economy, too, will begin to bake into Fed polices, such as COVID-19’s impact on employment. The Fed is a trusted source for these insights and an often-overlooked place for investment ideas based on micro economics.
In our next column, we’ll look at the past, present and future role of the Fed.
Thomas Kostigen is a contributing writer to MyPerfectFinancialAdvisor, the premier matchmaker between investors and advisors. Thomas is a best-selling author and longtime journalist who writes about environmental, social, and governance issues.
