The Fed’s Raised Interest Rates, Again: What’s next

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No surprises and strong data

The Fed meeting wasn’t much of a surprise, as markets highly anticipated the raise of the target range for the federal funds rate to ¾ to 1 percent. As noted in the Fed’s press release, “the stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained return to two percent inflation.”

In its statement, the Fed also succinctly summarized a lot of the good recent economic data that has, in part, been fueling a strong equity market. Here are the highlights: job gains remain solid, the unemployment rate is healthy, household spending has been increasing, and inflation has been moving closer to the Fed’s two percent long-run objective. Again, nothing really unexpected with these statements.

However, looking deeper into some of Yellen’s comments during her interview, we found some commentary with important implications for a few of the major risks in retirement portfolios specifically: longevity risk, inflation risk and interest rate risk.

Inflation is under control

First up, inflation risk. The Fed’s expectation is that core inflation will “stabilize around two percent in the next couple of years,” indicating a stable outlook from the Fed’s perspective. The Fed also gave some encouraging guidance on how it could help to mitigate inflation risk. When asked about overshooting inflation, Yellen responded that “if there were an overshoot and it appeared to be persistent, we would put in place policies to try to bring inflation back to two percent.” These comments suggest that this Fed will keep inflation in check.

Small rate changes could continue to have large impacts

Next up, interest rate risk. As we have written about in a previous blog post1, the fed funds rate affects all other rates downstream (recall that Q4 was the worst quarterly return for the U.S. aggregate bond market since the early 1980s). Yellen reiterated an observation that we have all known to be true for quite some time, that rates are “currently quite low by historical standards” and that the fed funds rate “does not have to rise by all that much” to become neutral again. As low rates are likely to persist for some time, we can continue to expect Fed decisions and commentary to bring a significant amount of headline risk, adding more uncertainty to portfolios heavily allocated to fixed income securities.

Equity market stimulus doesn’t appear at risk

Finally, longevity risk. In spite of the second rate rise in three months and median expectations for 2017 year-end rates hovering around 1.4%, the committee expects the federal funds rate to remain “below levels that prevailed in previous decades.” Additionally, the current sentiment of the Fed is that it isn’t in a hurry to remove stimulus from the markets. Another topic was uncertainty around fiscal stimulus, and Yellen was unwavering in her comments that more concrete plans on fiscal stimulus are needed before the monetary policy will react. These comments suggest continued downward pressure on the returns for fixed income portfolios.

So all in all here is what we have: strong data and a healthy economy, a Fed poised to react to fiscal stimulus, and an overall accommodative tone. We reiterate here our support of the opinion our Chief Global Strategist Greg Valliere stated in his Capitol Notes, “Story of the month: we’re nowhere close to the point where Fed rate hikes will derail this market.”

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