Fed Breaks the Ice
December 18th, 2015 | Work to Wealth
Wednesday’s announcement, a unanimous vote from the members of the Federal Open Market Committee (FOMC) to increase their target interest rate by 25 bps is historic, not only because it is the first rate increase in 9 years but because the FOMC is signaling another step to the end of accommodative monetary policy. The FOMC’s release stated that improving household spending, stronger business investment, and a stronger job market are evidence of a growing economy which can support a return to normalizing interest rates. Inflation is falling below the FOMC’s 2% target due to weakness in energy prices, but that is seen as a “transitory” effect that will improve in the near term alongside a strengthening job market.
In response to the financial crisis of 2007-2008, the FOMC took action by buying bonds in the programs called Quantitative Easing (QE) in an effort to lower interest rates, which in turn would help stimulate the economy. Now that the FOMC’s economic metrics have improved, it is taking a “gradual” path to more normal rates and policy, by keeping a large part of their accommodation in tact. The part that remains the same is the reinvestment of the proceeds of the maturing bonds into new bonds. The FOMC stated that this policy will remain in place until the normalization of rates is “well under way”. This policy will continue to provide a large amount of liquidity to the economy, which could have an even greater overall effect than the 25 bps rise in the target rate, as it is similar to the quantitative easing policies of the past.
In response to the FOMC’s comments, the markets were initially weak but then rallied as more information was shared by Chair Yellen. However, in similar fashion to the last FOMC decision, the following days’ market action reversed course. If the economy is improving, alongside the job market and household spending, then why would their policy change be so “gradual”? Maybe Wednesday’s decision was just about breaking the ice and getting started on a path back to higher rates. Or maybe there is some concern that the sluggishness of the recovery since the crisis, is translating into sluggish future growth. Their own estimates point to an increase of the target rate range from today’s .25% to .50%, to 1.40% by the end of 2016 and just 2.40% by the end of 2017. At that pace, it may take quite a long time before rates come anywhere close to 2006 levels. If those projections do prove to be accurate, that could indicate much slower domestic and global growth well into the future.
At DeCesare Retirement Specialists we prioritize safety of capital above growth opportunity during volatile times. We continue to employ counter risk measures alongside a prudent growth strategy in order to protect capital in what continues to present as a challenging economic and investment environment.
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