The Federal Reserve raised its benchmark interest rate on December 16, 2015 after seven years of maintaining a near-zero interest rate policy. The Fed also laid the groundwork for further rate increases in 2016 and beyond. It is our opinion that additional rate increases will likely not be dramatic and will be determined by how the economy performs.
The Fed increased its federal funds target to 0.25-0.50% from 0-0.25%. It was the most widely anticipated interest rate change since the Fed lowered rates to zero during the Great Recession in an effort to spark economic recovery. The last rate increase by the Fed was before the financial crisis a whopping nine years ago.
The decision to raise interest rates has become the most widely discussed – and debated – piece of financial news in recent memory. It is widely discussed because the Fed’s interest rate policy touches upon nearly all domestic and international financial markets in one way or another. The Fed’s decision has been debated because evidence of the U.S. economy’s recovery, as measured by inflation targets and improvements in labor markets, may not point to the economic vibrancy that many economists think would justify an interest rate increase.
So why did the Fed raise rates if economic growth is just “so-so”? To offer a simplified answer, we believe it is because although the Fed realizes economic recovery is not as strong as it would prefer to see, it expects growth to pick up pace in 2016 and beyond. Thus, their decision on December 16 was based on expectations. The rate increase of 0.25% on December 16 was minor in the big picture. One might argue the rate increase was symbolic as much as anything, and it lets the Fed keep its options open next year.
Our clients may be wondering what this news means to their portfolios and financial plans. Although interest rate changes impact most investments, those impacts are often gradual. It is important for our clients to maintain a long term perspective based on their unique needs. News events like this are good tools for planning ahead, but they alone are not a reason to change a long term investment strategy on short notice.
One of the most important things for investors to be reminded of is the importance of reviewing their asset allocations regularly. Over time, changes in interest rates will impact the values and yields of bonds and CDs, as well as the performance of stocks and other assets. Again, changes as a result of the Fed’s interest rate policy may not be immediate. We welcome our clients to reach out to us over time to ensure they remain comfortable with their portfolios throughout this new economic era.
