Reaction to the Federal Reserve’s Inaction

The Federal Reserve again left short term interest rates unchanged at near zero, at the conclusion of their two day September meeting yesterday.  They will next meet in October and December, 2015.

When was the last time the Federal Reserve increased interest rates?

There has been no change to short term rates since 2008, which have basically been at 0% since then. They last raised rates in 2006.  The Federal Reserve directly influences short term interest rates and indirectly can cause changes in longer term interest rates.

Was the Federal Reserve expected to raise interest rates yesterday?

The Federal Reserve dual mandate is to “foster maximum employment and price stability” (keep inflation around 2% annually).  Many forecasters expected at the beginning of 2015 that there would have already been at least one .25% raise by now.

Due to “recent global economic and financial developments,” the Fed decided to leave the fed funds target range at 0 – 1/4%.  This implies that the Fed did not raise short term rates yesterday due to their concern about the Chinese economy and the huge decline in oil prices and other commodities.  These “are likely to put further downward pressure on the inflation in the near term.”

In her press conference after the Fed press release, Fed chairwoman Janet Yellen said that thee US economy has been performing well, but they did not raise rates at this time primarily due to the recent financial uncertainty.

When is the Fed expected to increase interest rates and by how much?

In their projections, 13 of the 17 Federal Reserve board members believe the Fed will raise rates before year end, in either October or December.  This initial rate increase would likely be .25%.  The key factors are “developments abroad,” labor markets and oil prices.

The board members short term interest rate expectations by the end of 2017 are 2.6%, which is lower than the 2.9% they predicted in their June, 2015 release.  This would imply that short term interest rates on investments like 1-3 year CDs would be around 2.5-3.0% by the end of 2017.  The Fed board member projections have been consistently inaccurate the past few years, but are helpful as an indication of their expectations.

What does the Fed think of the US economy?

The formal Federal Reserve statement “suggests that economic activity is expanding…moderately.” Household spending, business investment, housing and the labor market all continue to show progress and improvements.  These all appear to be positive comments.

How does this meeting and the related information impact our investment strategy?

We expect that the Fed will increase interest rates very gradually, beginning later in 2015.  This bolsters our confidence about the US and world economy.  A very gradual increase in interest rates should be welcomed.

The continued recovery of the economy and still historically low interest rates should provide for growth in corporate earnings.  This should lead to gains in stocks over the long term, of course with volatility along the way.

We remain committed and confident in our long term philosophy of a globally diversified stock portfolio along with an appropriate fixed income allocation, based on your personal situation.

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