By David Guttery
At long last, after seven years of near zero percent short-term interest rates, the Federal Reserve unanimously decided to raise rates by 0.25 percentage points, the first rate hike since 2006.
Meanwhile, the Fed will lift the interest it pays banks to hold reserves to 0.50% from a prior 0.25 percent. In addition, the Fed will offer reverse repo’s at 0.25 percent to help drain reserves from the financial system so they can keep the funds rate at or above 0.25 percent. Another change was lifting the discount rate to 1.00 percent from 0.75 percent.
The Fed improved its assessment of the labor market, noting “ongoing job gains, and declining unemployment,” and wrote that under-utilization of workers has “diminished appreciably.” It also noted that even after the rate hike “monetary policy remains accommodative” and that risks to the outlook are “balanced” versus “nearly balanced” in prior statements.
Ultimately, what matters the most in the rate change decision for projecting future rate hikes is the “dot plot” from the Fed. This remains very close to what the Fed showed three months ago, with the median decision-maker projecting four 25 bp rate hikes next year and another four in 2017. This is completely consistent with economic projections that are very little changed from three months ago, and the Fed continuing to assert that policy will be dependent on the data.
At present, the federal funds futures market anticipates only two rate hikes next year. I think rate hikes are much more likely to come in as the Fed now projects, with the Fed raising rates at every other meeting in 2016, or once per calendar quarter. In turn, this means interest rates across the yield curve should rise a bit faster and further than the market now expects.
Even with the rate hike and a median projection of four more in 2016, the Fed says the labor market will continue to strengthen and the unemployment rate will hover for multiple years below 4.9 percent, which is what the Fed thinks is the long-term norm.
It is long past time for the Federal Reserve to have started raising rates. The unemployment rate is already very close to the Fed’s long-term projection of 4.9 percent and nominal GDP growth, (real GDP growth plus inflation), is up at a 3.9 percent annual rate in the past two years.
This much anticipated rate hike isn’t going to hurt the economy. I believe it will help the economy by signaling the eventual end to a policy that has distorted economic decisions for the past several years.
Source – Federal Reserve Commentary Wednesday, 16 December 2015
David has been in practice for 24 years, with a distinctive focus on the management of retirement assets for the production of durable income. David R. Guttery, RFC, RFS, CAM, is an Investment Advisory Representative of Ameritas Investment Corp, and President of Keystone Financial Group, in Trussville, Alabama. David independently offers securities and investment advisory services through Ameritas Investment Corp. (AIC) member FINRA/SIPC. AIC and Keystone Financial Group are not affiliated. Additional products and services may be available through David R. Guttery or Keystone Financial Group that are not offered through AIC.