What The Federal Reserve Rate Hike Means To You

US Wealth Napolitano |

By: Burt White, Chief Investments Officer,  LPL Financial

Dear Valued Investor:

The events of last week bring one word to mind: finally. Last week the Federal Reserve (Fed) finally raised the target for the federal funds rate by 0.25%. By raising this key overnight borrowing rate, the Fed raised interest rates for the first time in nine years — an event that has been receiving a great deal of attention recently. Surrounding the past several Fed meetings, there has been much talk of “will they” or “won’t they.” Leading up to this meeting, the Fed implied it would raise rates, and the market was expecting it. However, until the announcement was made last week, a degree of uncertainty remained.

So, what does this really mean? It means the potential for key rates to tick up, such as mortgage or credit card rates. Most bonds have “priced in the hike,” but some could still feel a slight negative impact. However, overall, we should take this as a positive sign. We have not experienced a rate hike in nine years, and, perhaps more importantly, we have not had rates above the 0 – 25 basis point range (0 – 0.25%) since late 2008. The Fed said it would only raise rates if the economic data signaled a healthy economy. We have seen strong numbers posted over the past few months, and the Fed affirmed last week it believes this trend should continue. To sum up, the Fed has raised rates because it believes the economy is strong and likely to continue to grow without the added support of near zero interest rates.

For the market, this is potentially a positive event. Yet, rate hikes also reaffirm that we are in the mid-to-late stage of the economic cycle. In this part of the cycle, we can expect additional market volatility. We especially anticipate it in the coming weeks and months, as investors become comfortable with the “new routine” for U.S. monetary policy.

Although we have just experienced the first raise, many will immediately start thinking about what’s next. The debate will continue regarding how fast the Fed will raise rates, how far it will raise them, and when it will stop. Last week the Fed’s own projections put the fed funds rate at 140 basis points (1.4%) a year from now, while the fed funds futures market puts the fed funds rate at just 80 basis points (0.80%) by year-end 2016. This difference implies a gap between what the Fed says it will do and what the market thinks the Fed will do. How this gap is resolved will play a key role in the future direction of financial markets, particularly fixed income markets.

Luckily, Fed Chair Janet Yellen is aware that markets will continue to debate what may lie ahead. Her comments during the post-meeting press conference suggest the Fed will continue to proceed cautiously, taking into consideration the impact of rising rates on consumer spending, the housing market, business capital spending, the value of the dollar, and overseas economies and financial markets. A slow path for further increases will give the economy and markets time to adjust to the changes.

It has been a long time since we last saw the Fed hike rates. It does feel unusual, but also positive, and hopefully this change is well worth the wait. It means that we are returning to a more typical economic environment, which is a welcome change from the atypical environment we have lived in since the Great Recession. And even though this is a big change in Fed policy, what shouldn’t change is our commitment to the long-term investment plan that is ultimately our blueprint for success.

As always, we encourage you to contact contact us with any questions that you may have.