Wall Street rallies as interest rates rise for the first time since 2006.
Presented by Gray Equity Management, LLC
U.S. monetary policy officially changed course Wednesday. Federal Reserve officials voted to raise the federal funds rate by a quarter of a percentage point, ending an unprecedented 7-year period in which it was held near zero. Nearly ten years had passed since the central bank had adjusted interest rates upward.1
The Federal Open Market Committee voted 10-0 in favor of the rate hike. It also raised the discount rate by a quarter-point to 1.0%.1
Addressing the media after the FOMC announcement, Federal Reserve chair Janet Yellen shared the central bank’s viewpoint:“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.”2
Equities started the day with minor gains, then advanced further. The Dow Jones Industrial Average, S&P 500, and Nasdaq Composite respectively advanced 1.28%, 1.45%, and 1.52% Wednesday. The yield on the 2-year Treasury hit a 5-year high of 1.021%. Gold rose $15.20 to close at $1,076.80 on the COMEX.3,4
As a December rate increase was widely expected, the real curiosity concerned the following press conference. Would Janet Yellen offer any hints about monetary policy in 2016?
She offered one: she said she doubted that any interest rate hikes in 2016 would be “equally spaced.” Aside from that remark, no new insights emerged; Yellen reemphasized that the Fed does not plan to raise rates aggressively.2
Investors gained more insight from the Fed’s latest dot-plot chart, which expresses the Federal Open Market Committee’s opinion on where the benchmark interest rate will be at near-term intervals. The new dot-plot forecasts four rate hikes during 2016, with the federal funds rate climbing toward 1.5% by the end of next year (the median projection is 1.4%).5
The dot-plot revealed benchmark interest rate targets of 2.4% for the end of 2017 and 3.3% for the end of 2018, slightly lower than the previously stated targets of 2.6% and 3.4%.5
That corresponds with the consensus of analysts surveyed by CNBC. Their expectation was for three quarter-point rate hikes across 2016, taking the federal funds rate toward 1%.6
\Some analysts wonder if the next rate hike might occur at the FOMC’s March meeting. Nothing could be gleaned about that from Yellen’s press conference or the new FOMC announcement.6
With more tightening seemingly ahead, what is in store for the bull market? Bears may want to wait before making any gloomy pronouncements. While rising interest rates are commonly assumed to impede a bull market, this is not always the case. In fact, the S&P 500 advanced 15% during the last round of tightening (2004–06).7
Could higher interest rates decrease inflation pressure? That is a distinct possibility, and that would hurt wage growth and business growth. The Fed would like to see inflation in the vicinity of 2%, yet the Consumer Price Index is up only 0.5% in the past 12 months, held in check by a 14.7% annualized retreat in energy prices and a 24.1% annualized fall in gas prices. On the other hand, the Core CPI (minus food and energy prices) is up 2.0% in the past year.6
The Fed may have made just the right move at the right time. If it had waited until 2016 to tighten, a collective “uh-oh” might have been heard from pundits and analysts, with comments along the lines of “Does the Fed know something about the economy that we do not?”
As JPMorgan Private Bank chief U.S. investment strategist Kate Moore told CNNMoney this week, “Keeping interest rates at zero is enforcing the idea that the U.S. economy is fragile.” Years of easing certainly helped the bull market, though: Wednesday morning, the S&P 500 was 202% above its March 9, 2009 bear market low.2,7
Ultimately, the central bank felt the time had come for tightening. At Wednesday’s press conference, Yellen commented that data had led the Fed to raise rates – it had not made its move in response to any shifts in public opinion. “Consumers are in much healthier financial condition” than they once were, she remarked. The rate hike certainly expresses confidence in the economy, which could strengthen further in 2016
Gray Equity Management, LLC
150 Royall Street
Canton, MA 02021
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