And So It Begins, The U.S. Federal Reserve Increases Rates

December 14, 2016

Earlier today, the U.S. Federal Reserve (Fed) announced it would increase the federal funds rate target by 0.25% to 0.50%-0.75%. The decision comes as no surprise as the Fed had signaled it would be increasing rates at its December meeting.

First hike since December 2015, second since 2006

The Fed last raised rates at its December 2015 meeting and at the time signaled it would raise rates four more times in 2016. It did not, as the economy struggled through the first half of the year.

Since then, growth has been more robust and there has been continued progress towards the Fed’s inflation and employment goals. Ten year inflation expectations have moved higher, currently sitting at 2.0%. Unemployment is currently at 4.6% and many believe and that lower unemployment rates could lead to significant wage inflation.

Looking ahead to 2017 and beyond

A 0.25% increase, while small, could still have implications for the global economy. While the Fed is cautiously increasing rates, most developed nations (Canada, Japan, Euro region) are either lowering or staying put on already accommodative monetary policy. This divergence could lead to a stronger U.S. dollar, higher bond rates, lower commodity prices and weaker foreign denominated corporate profits.

While the Fed’s increase to the Fed funds rate was widely anticipated, what came as a bit of a surprise to investors was the Fed signaling that it expects to increase the target rate an additional three times in 2017. Investors were pricing in two increases, not three. The initial reaction to this has been a dip in equities and a reversal in oil prices. We have also seen a rise in the U.S. dollar and the 10 year U.S. treasury yield.

Long-run growth, unemployment and inflation outlooks remain unchanged since the September meeting at 1.8%, 4.8% and 2.0% respectively.

Over the short-term, the announcement may impact short-term borrowing costs. More importantly however, it indicates the Fed’s positive view on the U.S. economy.

What does this mean for MD portfolios?

Even though the Fed was more hawkish than expected, MD portfolios are well diversified to ensure that all known risks are accounted for and actively managed. MD builds our portfolios to meet your financial goals in the long-run.

Generally, the Fed’s announcement has minimal impact on MD Funds, Pools and the overall positioning or performance of your portfolios.

The Fed’s decision to increase rates is confirmation of a strengthening U.S. and our investment views. MD’s tactical asset allocation decision remains overweight in U.S. equities because U.S. economic fundamentals remain strong, especially when compared with other regions. Similarly, our U.S. dollar exposure remains unhedged, as we expect a stronger greenback. 

We encourage you to contact your MD Advisor if you have any questions.

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