U.S. Federal Reserve Still Likely to Raise Rates in 2016

September 22, 2016

As expected, the U.S. Federal Reserve (Fed) left the Federal funds rate target unchanged at 0.25%-0.50% at their meeting on September 21, but the surprising part was the votes against the decision.

Rate Increase Hinted by Divided Fed

Regional Presidents Esther George (Kansas City), Loretta Mester (Cleveland) and Eric Rosengren (Boston) all wanted to raise the target to 0.50%-0.75% and dissented.

Since the end of the recession in 2009, decisions at most Federal Open Market Committee (FOMC) meetings have been unanimous—or with one dissension. Having three opposing representatives is a clear sign that members believe a target rate increase is warranted and projects that a hike is still likely for 2016.

Cautious Fed Looking for More Evidence of Progress

Fed Chair Janet Yellen made it clear at the start of her press conference that the decision to maintain rates does not reflect a lack of confidence. In fact, the Fed had stated that near-term risks to the economic outlook appear roughly balanced. Furthermore, the Fed specified that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress towards its objectives.

Initial Reaction Has Been Positive

Global markets reacted favourably to the Fed’s announcement–equities rose, the U.S. dollar dropped versus the majority of its peers as did government bond yields. Mixed messages from the Fed earlier in the month created market volatility as investors became unsure of the path that the U.S. central bank policy would take.

The decision to hold rates steady for the time being can be seen as the Fed’s commitment to boost growth, while the signal of a near-term hike suggests confidence in the U.S. economy.

How Does the Decision Impact MD Portfolios?

In general, the Fed’s announcement has minimal impact on MD funds or pools. We do not expect the announcement to have material impact on the overall positioning or performance of your portfolios. The announcement may slightly influence certain companies, currencies and bond yields.

Despite the potential for a rate increase in the near future, we believe that central banks around the world will continue to be accommodative in their monetary policies which should benefit equities. This would be supportive of MD’s tactical asset allocation decision to overweight equities, in particular U.S. equities. We will continue to monitor markets and will make appropriate adjustments if necessary.

We encourage you to review U.S. Federal Reserve and Bank of Japan Leave Rates Unchanged, and contact your MD Advisor if you have any questions.

By the Numbers

Here are the Fed’s expectations for future increases to the Fed funds rate.

 

2016

2017

2018

FOMC Meeting

Sept. 2016

June 2016

Sept. 2016

June 2016

Sept. 2016

June 2016

Median Rate Expectations

0.60%

0.90%

1.10%

1.60%

1.90%

2.40%

Source: https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20160921.htm

The Fed expects one more rate increase this year and one to two rate hikes in 2017. The FOMC is scheduled to meet at the beginning of November, within a week of the U.S. presidential election.

FOMC members expect future rate increases to be gradual and that the Fed funds rate will remain below levels that are expected to prevail in the long term. The slower-than-expected pace of increases will be viewed favourably by investors and should offset the near-term expectations for a rate hike.

Economic Expectations

The Fed’s objectives are stable inflation and maximum employment. Inflation has continued to run below the 2.00% long-term objective. The Fed stated that it expects inflation to remain low in the near term due to low energy prices and prices of non-energy imports but expects to reach the target in the medium term.

The labour market has continued to strengthen and economic growth activity has picked up from the modest pace seen in the first half of 2016. The Fed noticed that while the unemployment rate had remained unchanged from the previous meeting, job gains had been solid, leading to strong household spending. The one weak point in the economy was business spending which remains depressed.

The Fed released projections for a number of economic variables from now through 2019. Expectations for 2016 real GDP have been lowered from their previous projections. Expectations for the unemployment rate and core inflation changed little from the previous meeting as Fed members expect full employment in 2017 and for core inflation to be slightly below their target.

 

2016

2017

2018

2019

FOMC Meeting

Sept. 2016

June 2016

Sept. 2016

June 2016

Sept. 2016

June 2016

Sept. 2016

June 2016

Change in Real GDP

1.80%

2.00%

2.00%

2.00%

2.00%

2.00%

1.8%

N/A

Unemployment

4.80%

4.70%

4.60%

4.60%

4.50%

4.60%

4.60%

N/A

Inflation

1.70%

1.70%

1.80%

1.90%

2.00%

2.00%

2.00%

N/A

Source: https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20160921.htm

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