Fed Surprises Few With Rate Hike

At its March 15 meeting, the Federal Open Market Committee (Fed) did what many expected: raised the target federal funds rate to between 0.75% and 1%. The 25-basis-point increase was in line with market expectations and reflected “the economy’s continued progress toward the employment and price stability objectives,” according to Federal Reserve (Fed) Chair Janet Yellen. The central bankers last raised rates three months ago at their mid-December meeting.

It should be noted that senior Fed officials’ projections of growth, unemployment and inflation over the next few years didn’t change much from December. And, only a few Fed officials raised their expected year-end rate targets for 2017 and 2018. Future Fed policy actions will be data- dependent with a focus on the job market and the inflation outlook. The domestic equity markets were expecting a more aggressive stance on raising rates, but equity investors seem to prefer the gradual move toward normalization of fiscal policy. The measured comments from the Fed helped extend recent gains for all three major stock indices.* In addition, many types of bond prices were relatively steady, which meant that they had already “priced in” this interest rate increase.**

Background

As reflected in positive moves in both the stock market and relative steadiness of the quality bond market, the decision to raise short-term interest rates is not necessarily bad news for investors, Raymond James Chief Economist Scott Brown explains. It reflects an improved economic outlook. The latest employment report, for example, showed an uptick in construction and manufacturing jobs, a sign of strengthening business investment. Even with the rate increase, monetary policy remains accommodative. Consumer and business borrowing costs may rise moderately, but the economy is expected to strengthen further over the course of 2017.

The Fed may be on a collision course with policies coming out of Washington, notes Brown. Reduced regulation, a possible infrastructure spending package, and tax cuts should provide some lift for economic growth. In contrast, the Fed sees an economy near full employment. Labor market constraints would keep overall growth at a moderate pace. Of course, as Yellen has noted, the timing, size and character of Washington’s policy changes remain uncertain.

The rate increase was only the third since 2006. Any immediate effects will likely be modest, as they were in December. Banks tend to raise interest rates on loans before raising rates on

deposits, so borrowers should see a change first, while savers may have to wait a little longer to see their interest rates rise.

Many bond investors have been concerned about interest rate increases because bond prices do have an inverse relationship with rate increases. However, as we can see from this rate increase, the reality for bonds is much more nuanced and interest rates don’t move in lockstep with Fed policy.

We will, of course, continue to monitor the latest market and economic news on your behalf. Should anything change, we’ll be sure to share the most relevant updates with you along with implementation of strategies as appropriate. Please know that we were expecting the Fed’s action of yesterday and had already incorporated that into our advice to you.

As always, please let us know any questions or comments. 

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*Dow Jones Industrial Average: The Dow Jones Industrial Average is a composite of 30 stocks spread among a wide variety of industries, such as financial services, industrials, consumer services, technology, health care, oil & gas, consumer goods, telecommunications, and basic materials. The index represents approximately 23.8% of the U.S. market, and is price weighted (component weightings are affected by changes in the stocks’ prices).

*S&P 500: Representing approximately 80% of the investable U.S. equity market, the S&P 500 measures changes in stock market conditions based on the average performance of 500 widely held common stocks. It is a market-weighted index calculated on a total return basis with dividend reinvested.

*NASDAQ Composite: Including over 3,000 companies, the NASDAQ Composite is an index measuring all NASDAQ domestic and international based common equities listed on The NASDAQ Stock Market. Most companies represented are technology and Internet-related, but there are financial, consumer, bio-tech and industrial companies as well.

**As measured by the Vanguard Total Bond Market ETF (BND), as of 12:00 p.m. CST, March 16, 2017.

Laura Kuntz