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Federal Reserve raises interest rates from near zero to 0.25-0.50 percent

INSIGHT ARTICLE  | 

For the first time since June 2006, the Federal Reserve has raised interest rates from near zero to 0.25 - 0.50 percent. This raise is also the first Fed move since rates were lowered to near zero in December 2008 in order to support a struggling economy in the middle of the Great Recession. Never has a quarter point increase in the Fed Funds rate created such attention.

Discussions of a Fed move is something we have been highlighting in many of our monthly commentary pieces over the last seven years. As stated before, the timing of rate hikes is less important than the speed and size of the increases. Additional rate hikes over the coming few years are expected to be “low and slow” or gradual rather than “one and done” or having abrupt increases.

The Fed was clear there is no set path for future rate increases. Chair Janet Yellen said the economy is performing well and the policy-setting committee has confidence it is still strengthening. However, the Fed believes there is still room for improvement in the labor markets and inflation remains below its 2 percent target due to transitory factors like low energy prices and dollar strength. The Fed expects inflation to return to the 2 percent target over the medium term, which is part of the reason why the committee made the increase now. Future increases will continue to be data dependent, though the Fed was not terribly explicit with what those measures would be. Whether looking at the Fed dot plot or by listening to pundits, there is already disagreement and debate as to possible Fed action in 2016 and beyond. Finally, remember the Fed only controls the short-term portion of the yield curve. The intermediate and longer ends of the curve are driven by other factors like market demand and inflation expectations.

From an investing perspective, the concern is a rate increase could hurt equity markets as capital costs increase. However, equity market results have been mixed following periods of rate increases historically. We also know markets don’t like uncertainty and with this announcement, there is some amount of decreased monetary policy uncertainty. The Fed’s statement expressed confidence in the economy, which could also be a positive sign for equities. In addition, we also recommend global bond investing, which allows investors to diversify yield curve and interest rate risk. Overall, there have been winners and losers during the zero-rate era with some of the risk and rewards of this period still not fully understood.

RSM US Wealth Management is not suggesting investors make changes in their portfolios based upon this minimal change. Fed policy is still incredibly accommodative and active investment managers will be reviewing investment portfolios and positioning them in the manner they deem best. The RSM US Wealth Management investment team will continue to monitor our recommended managers to make sure they are meeting or exceeding our expectations. As always we recommend periodically evaluating your portfolio for rebalancing opportunities that may be available.

Separately, after the announcement several banks quickly announced a corresponding 25 basis points increase in the prime rate, which relates to the rate some banks charge borrowers for small businesses loans, mortgages and personal loans as examples. Expect most if not all banks to follow behind very quickly in raising their prime rates. Unfortunately, banks are not expected to increase deposit rates upon this announcement, meaning savers will not see immediate benefit from this rate increase. It is also not expected for money market funds to increase rates as the firms that manage money market funds have essentially been subsidizing costs for the last several years and will likely be looking to recoup at least some of these costs.

Please read Fed hikes rates in most dovish way possible  by Joe Brusuelas, RSM Chief Economist, for his view on the rate increase and what it means for the global economy.

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