Last week the Fed surprised no one by keeping the federal funds rate at a range of 0.25%-.50% and reducing the expectations for rate hikes for the next few years (see chart below). This move was well telegraphed and the markets are certainly in the “lower for longer” camp as they believe the fed funds rate will remain at 1.5% well into 2018.
As Charlie Toole pointed out two weeks ago, we are in the camp of expecting multiple rate hikes this year and nothing in the most recent Fed announcement changes our opinion. The Fed stated it is expecting two rate hikes in 2016 down from the four rate hike expectation that was signaled in December of last year. Any interest rate hike in the short term may cause increased volatility in the markets as two fed governors came out this week and signaled for a possible rate hike as early as the April meeting.
We are not as concerned about short-term hikes by the Fed as we believe that getting back to a “normal” interest rate level is important for the economy and for investors in the long term. It is debatable whether raising short-term interest rates from zero to a more normal level of one to two percent would be considered tightening. A gradual rise in interest rates over the coming years should not harm the economy and in fact should be a net benefit to the economy as cash will start earning a return for savers across the country. This would be ideal for the equity markets as history shows these markets do not start to suffer until the ten year yield reaches above five percent.
We are a long way off from a rise in interest rates causing a tightening and a slowdown in the economy. As stated previously, a measured pace of rate increases over the next several years should be beneficial to savers as well as equity markets.
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