Federal Reserve, Interest Rates, Stock Market and Odds

When will the Federal Reserve next increase short term interest rates?

The next move may be as early as September 21st, based on a speech last Friday by Federal Reserve Chair Janet Yellen. At the annual Federal Reserve research conference she said “the case for an increase in the federal-funds rate has strengthened in recent months.”

She based her comments on “the continued solid performance of the labor market and our outlook for economic activity and inflation.”

Of course, her comments were qualified that any decision would be based on more economic data. Later in the day, another Fed Board member stated two quarter point increases were possible yet this year.

What is surprising is that most Wall Street forecasters are not anticipating a September rate increase. Goldman Sachs said last Friday that Yellen’s speech increased the odds of a September increase from 30% to 40%. Fed fund futures see only a 27% likelihood of a September rate increase and the odds of a December increase at 59%.

What are the implications to you?

We want you to be prepared for possible strong reactions by the financial markets to the Fed’s future decisions, whether they raise rates or don’t raise rates in September or December. We want you to be prepared if the financial markets react in sudden ways to Fed statements, speeches and decisions.

The stock market does not like surprises. And though there are early indications of future rate hikes this fall, it seems that many on Wall Street are not realizing this yet.

If economic data continues to be positive and job growth is in excess of 170,000 per month, the Fed may increase short term interest rates by .25% in September and/or December. As Wall Street is not anticipating these increases, and clearly not two increases, these moves would be a surprise to many institutions. This could lead to volatility in the stock and/or bond markets. This potential volatility should not affect you and will not affect our short or long term investment strategy.

We think the economy is strong enough for these rate increases and these moves would be positive, even if they cause a near term negative market reaction. The US economy will not come to a screeching halt if short term interest rates go from 1/2% to 3/4% or even….hold your breath….to 1% by the end of 2016. Interest rates are still incredibly low and even after these increases, whenever they do come, rates would still be historically very low.

Keep in mind that the Fed can only directly impact short term interest rates. Broader trading and expectations influence longer term interest rates, such as the 10 and 30 year Treasury notes and bonds, as well as longer term corporate bonds and bank CDs.

Our investment strategy of not making interest rate bets is still appropriate, as guessing the actual moves of the Fed is very difficult. We will continue to recommend holding a diversified portfolio of high quality bonds and fixed income securities, with varying maturities, or short term bond funds, as applicable.

That the Fed is considering interest rates increases is indicative of the continuing positive economy and stronger labor market. Inflation is well under control. Despite what politicians and the media say, real economic data has continued to be stronger, not getting weaker.

While there is still room for more economic growth, the economy is not worsening. Despite what the stock market may do in the short term, we remain rational optimists for the long term. The stock market has increased and will continue to do so in the future. We strongly recommend maintaining a globally diversified stock allocation that is appropriate for your risk tolerance and time horizon.

Be prepared for gradually rising interest rates.

They are a good sign.

The stock market can always be risky. But if you stay in the game, and remain invested, you will benefit in the long term.

If you have questions, contact us. This is what we are here for.

Note: This blog post was written on Thursday, September 1, before the monthly jobs report was released at 8:30 AM on Friday, September 2nd. This jobs report may have a significant impact on the Fed’s thought process and decision at their next meeting, scheduled for September 20-21.

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