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Raised the Rate

After years of waiting it finally happened. Christmas came early as the federal funds rate increased by a quarter of a percentage point +0.25% yesterday, ending an unprecedented seven year period in which it was held near zero. The Federal Open Market Committee voted unanimously in favor of the rate increase and also raised the discount rate by a quarter point to 1%.

After the FOMC announcement, Federal Reserve chair Janet Yellen shared that with the economy performing well, and expected to continue to do so, the committee judged that a modest increase in the federal funds rate target is now appropriate, recognizing that even after this increase, monetary policy remains accommodative.”

We are relieved the Fed finally took action because we feel the uncertainty of an increase has lead to much of the recent volatility in domestic equity and debt markets. While a December rate increase was widely expected, the real question was if Janet Yellen would offer guidance about monetary policy for the year ahead.

She offered a couple hints, emphasizing that the Fed does not plan to raise rates aggressively. In addition she stated that “recent global economic and financial developments are likely to put further downward pressure on inflation in the near term. These developments may also restrain U.S. activity somewhat”. We believe the Fed will closely monitor the impact of this initial increase and hold off until the second half of 2016 before considering additional tightening.

What does this mean for the bull market? Bears may want to hold off on making any gloomy pronouncements. While rising interest rates are commonly assumed to impede a bull market, this is not always the case. As a matter of fact the last round of tightening (2004 – 2006) saw the S&P 500 advance about 15% through the same period. The Fed tightening should be seen as a sign of an improving economy and now the focus will shift back to corporate earnings and economic growth.

Higher interest rates could decrease inflation pressure, and that would hurt wage growth and business growth, but let’s not get ahead of ourselves. The Fed would like to see inflation around 2% but the Consumer Price Index is only up 0.5% over the past 12 months, held down by a significant retreat in energy prices. Interestingly, this move is being made at a time which other global central banks are becoming increasingly accommodative with their monetary policy which we believe will lead to an even stronger dollar in the short term.

Was this the right move at the right time? If the Fed had waited until 2016 it’s possible they would have lost even more credibility. After the last two meetings in September and October investors were beginning to wonder if the Fed knew something about the economy that no one else did. Maintaining rates at zero was reinforcing the idea that the U.S. economy is fragile and has lead some investors to take on more risk than was appropriate.

Ultimately this isn’t that big of a deal, while it was indeed an increase it was a minor increase and the sky is not falling. We are in agreement with Yellen that “consumers are in much healthier financial condition” than they once were and the rate hike certainly expresses confidence in the economy moving forward.

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About Stephen Rischall

Stephen is an award winning fiduciary financial advisor. He began learning to invest at the age of 13 and helped manage the University Corporation Student Investment Fund while studying finance in college. Stephen has been featured as the financial expert for millennials on live radio and in the news. He is an avid adventurer and is passionate about helping people make smarter financial decisions.
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