What's On Tap...

Fed Speak

The markets reacted negatively to comments made by Boston Fed Governor Eric Rosengren and famed investor Jeff Gundlach stating interest rates are likely to rise sooner rather than later.  I am not sure why this is such a surprise, as Janet Yellen was clear in her speech at Jackson Hole that the Fed has become more confident in the economic recovery and that the Fed is data dependent.  Since her speech, the economic data had been mixed so the odds of a rate hike in September diminished until the aforementioned comments.  The ten year yield spiked to 1.67% on Friday, which is still below   early June pre-Brexit.  As a result the markets were down 2-3 percent with interest rate sensitive sectors declining the most.

Monday afternoon, Fed Governor Brainard said that a rate hike is “less compelling” in the near term due to a lack of inflation and weak global demand.  Investors cheered this news and the market recovered more than half of Friday’s losses as the probability of a September rate hike lessened.   The differing opinions from the Federal Reserve policymakers has heightened volatility in the markets, however investors need to put this interest rate hike into perspective.

The Federal Funds Rate is at .5%, more than seven years after the last recession. In our opinion a 25bp hike is a positive for the economy as it signals the economy is on solid footing and allows savers to begin earning some interest on cash investments.  People are nervous that a small rise in interest rates will hurt the economy and cause a contraction or recession.  The rational thought is that a small hike in interest rates should have little effect on economic activity.  The Federal Reserve has signaled that it will be measured in its approach and have used the word “gradual” several times in the last few months.  A measured, gradual rise in interest rates should be viewed as a positive and that is what investors should be focused on.  The economic data in the U.S. as shown in the chart below supports a higher Federal Funds Rate.  

Source: ECRI

Source: ECRI

The Federal Reserve meets again in one week on September 21st.  At this meeting, it will give its current economic assessment and interest rate policy decision.  We will be listening closely but investors need to be focused on the long-term implications of a small rate increase rather than on how the near-term market moves based on what various Fed observers do or say.  The U.S. economy continues to be resilient and can withstand small, gradual increases in interest rates.  The market will be volatile around these decisions, but maintaining a prudent and well diversified long-term investment plan should be beneficial for investors. 


           Christopher Deeley, CFA

                 Portfolio Manager


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