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U.S. Federal Reserve Raises Rates as the Economy Continues to Strengthen

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In a nearly unanimous decision, the Federal Open Market Committee (FOMC) announced on December 13 that it will increase the federal funds target rate by 0.25%. The new target range for the federal funds rate is 1.25% to 1.50%.

The economy and labour market continue to expand

 The largely anticipated move affirms the Fed’s view that the U.S. economy has become strong enough to withstand reduced monetary stimulation. Economic activity is rising at a solid rate and labour market conditions remain strong. The Fed revised its unemployment rate expectations for 2018 to 3.9%, down from 4.1% in September.

GDP growth expectations revised upwards

Fed Chairwoman, Janet Yellen indicated that many members of the FOMC considered the impact of fiscal stimulus, including the potential for tax reform, on GDP growth. As a result, the Fed revised its expectations for real GDP growth in 2018 to 2.5%, compared to 2.1% in September, however most members don’t believe the impact of fiscal stimulus to have the same level of influence in 2019 and 2020.

Despite this more optimistic outlook for economic growth, the Fed maintained its expectation of three more 0.25% rate hikes for 2018.

Inflation remains stubbornly low

On a 12-month basis, overall core inflation—which excludes food and energy—remains below the Fed’s 2.0% target. The Fed made no changes to its inflation expectation for 2018, which remains at 1.9%.

U.S. equities rise slightly, while the U.S. dollar falls

The Canadian dollar rose slightly relative to the U.S. dollar following the Fed’s announcement, while the U.S. dollar also lost ground to many global currencies. However, the market appears to have largely taken the rate hike in stride, with U.S. equity markets reacting only slightly positively to the announcement. 

Overweighting U.S. equities

The Fed’s decision to increase the federal funds target rate by 0.25% was in line with our expectations. Our portfolios are currently positioned with a tactical overweight allocation to U.S. equities relative to other asset classes, and the Fed’s announcement further supports this positioning.

Although the federal funds rate is on the rise, we must keep in mind that rates remain low by historical standards and that U.S. monetary policy remains very accommodative. We therefore view these rate increases as confirmation from the Fed that the economy is on solid footing and that corporate earnings are strong, both of which should be positive for U.S. equities.

A view to the longer term

We believe this week’s increase in the target rate is unlikely to have much of an impact on market performance over the short term. However, the three additional increases expected in 2018 point to a gradual shift in the Fed’s monetary policy, which could have an impact on U.S. equities over the next several years.

After a strong bull market run of eight years, U.S. equities are becoming fully valued. With that in mind, we’ve positioned our U.S. portfolios somewhat defensively for the longer term, to reduce the risk of a potential market correction.

For now, we are not planning any changes to our tactical positioning, but we will continue to monitor the strength of the U.S. economy and evaluate the impact of future rate hikes from the Fed.

As Expected, The U.S. Federal Reserve Raises Rates

Earlier this afternoon, the Federal Open Market Committee (FOMC) announced that it will increase the federal funds target rate by 0.25%. The new target range for the federal funds rate is 1.25% to 1.50%.

Overall, the Fed appears to be more optimistic for economic growth in 2018, however it did not revise its projection for three 0.25% increases in 2018.

We’ve seen a slight positive reaction to the announcement in equity markets. Additionally, the Canadian dollar rose slightly relative to the U.S. dollar, as did many other global currencies in reaction to the Fed’s statement. 

MD will follow this blog post with more in-depth analysis about the announcement and what it means for your portfolios.


About the Author

Edward Golding, CFA, MBA, was an Assistant Vice President with the Multi-Asset Management team at MD Financial Management. He oversees the Canadian, Dividend and U.S. equity mutual funds and investment pools at the firm.

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