Feds Finally Raised Rates; What Does That Mean?

After much speculation, that started more than a year ago, the Federal Reserve has finally increased the federal funds rate on December 14, 2016. The Fed's chairwoman, Janet Yellen, had stated in 2015 that there would have to be real improvement in the unemployment numbers, and economic growth, before the central bank would take any action. But, in late 2015, the Fed was projecting four increases during 2016, with only this recent increase actually materializing.

The increase in their benchmark interest rate amounted to .25 percent. They also raised their target for short-term interest rates, putting them in a range of a half to .75 percent. The rate increase was only the second one in a decade; a significant event given the recent history of interest rates.

The Fed's chair, Yellen, said that economic growth had picked up from the stagnant numbers in recent years. She was optimistic about the economy in the near-term. With improvements in the economy can come inflation, so the Fed may continue on this course.

The educated guesses, by financial commentators, at the Fed's interest rate actions were not really anchored in the Fed's own previous statements about employment numbers and inflation. Despite that, the predictions early in 2016, impacted the markets and investment decisions. Yet, the job numbers and lack of inflation, were not reflecting the kind of stimulus required to make the central bank act as frequently as thought. In the new year, conditions may be different.

A Low-Rate Environment

Over the past seven years, GDP has not hit 3 percent. There has been no real signs of inflation. Real unemployment, reflected in the E6 unemployment figure, was always too high to warrant an interest rate increase. While the prognosticators were certain that one was on the horizon, the Fed was reviewing numbers that led to inaction. The time just wasn't right.

As 2016 wound up, and the new year begins with a suggestion of economic stimulus and growth, and the Fed's position may change considerably. The Fed is now projecting three or more increases for 2017, an increase from their last prediction in September. Economic growth for 2016 is projected to only be approximately 1.9 percent. The Fed predicts a higher rate of growth for 2017.

The stock market's rally was interrupted by the rate increase announcement and was down more than 100 points the same day. The increase makes the cost of borrowing for consumers and businesses more expensive. The increase may signal more frequent and larger increases with the economic stimulus believed to be introduced by the new administration. The Fed's anticipation of more rate increases also impacted bond holders, who have dumped bonds, pushing up yields.

The Fed had dropped rates to zero in 2008, during the financial crisis. But with more economic stimulus in 2017 and beyond, including consumer spending, inflation will creep back into the picture and rate increases won't be far behind. Another spark for inflation would be a brighter jobs picture and tighter labor market, increasing wages. Mortgages could be above 4.5 percent by the end of 2017.