Under any other circumstances, the first anything since 2006 would have spurred an exciting, volatile response.
When Federal Reserve Board Chair Janet Yellen and Fed governors unanimously decided to ratchet up interest rates on Wednesday, however, not only were traders not surprised, it didn’t even lead to a minor trading blip.
Maybe that’s because she’d telegraphed a rate hike so many times this year, truly nobody was caught off guard.
Or maybe investors simply don’t care, tacitly knowing the fundamental difference between a Fed Funds Rate of 0.25% and 0.5% is minimal at best (other than serving as a statement).
Whichever it was, there’s one burning question investors are quietly asking themselves now that rising interest rates are a reality: What’s next?
A Friendly Little Rate Hike
As has been the case since Ben Bernanke held the title, the market was just as interested, perhaps even more so, in the language of the Fed statement as it was in the rate hike itself. Janet Yellen made a point of making it clear she was still plenty dovish.
“The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation … In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”
In other words, the Federal Reserve was terrified to keep interest rates near zero in fear that it would send an alarming message; and a small, benign rate hike here should encourage consumers and investors without actually slowing down the economic engine.
As evidence of the notion that the Fed’s governors are keeping their foot on the rate hike brakes, take a look at the updated dot-plot posted with the official statement. The Fed Funds Rate is only expected (on average) to reach 1.25% by the end of the 2016. That means three more rate hikes in the coming year. Even so, that leaves interest rates at historically weaker levels.
And that’s just the Fed’s outlook, which is as much of a propaganda tool as it is a prediction. Traders are mostly making real-money bets that the Fed Funds Rate won’t reach 1% until 2017, implying only one rate hike in the coming year. Longer-term, traders also say 3.5% is the most likely cap, and that’s into 2018 and beyond.
Now What for Interest Rates?
To put it bluntly, if the Fed’s intent was to push interest rates up across the entire spectrum of the bond and lending market, it failed. The yield on 30-year Treasury bonds edged up only 2.99% on Tuesday to 3% at Wednesday’s close, and that yield has fallen back to 2.97% as of Thursday.
The lack of response to the news can largely be attributed to the fact that the rate hike came as no surprise whatsoever.
In an effort to sidestep a proverbial revolt from the equities market, Yellen has cautioned for months that Wednesday’s decision was in the cards, and has spent the bulk of the year convincing investors rising interest rates should be seen as glass-half-full evidence that the economy is doing well enough to withstand a little inflationary control. By the time the news was unveiled, it was already priced into both the bond and stock market.
Be that as it may, Yellen seems to understand any subsequent increase in the Fed’s primary tool to throttle interest rates will need be similarly “sold.” The dovish language appearing in Wednesday’s official policy statement has already started that sales pitch.
However the Fed handles it, investors don’t need to worry too much about soaring interest rates — not now or in the foreseeable future.
The bond and lending markets have largely disconnected themselves from the idea of one foundational rate to serve as the basis of all other interest rates, instead finding their own balance between supply and risk-adjusted demand.
It’s going to take a Fed Funds rate higher than 0.5% to create a true ripple effect on other interest rates. Consumers may not even notice the rise in the Fed Funds Rate until it’s above a percent.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.