As I’ve long pointed out on this blog, the Fed has been dying to raise interest rates in 2016, but each time a meeting came up that they were planning to announce an increase, something happened in the world that made the markets shaky, and rate hike even dicier. As a result, this December 2016 interest rate hike is the one and only rate hike for the year.
The current interest rate increase takes the Fed’s main short-term interest rate to 0.50% (officially 0.5% to 0.75%) from 0.25 percent.
The Fed and 2017
Ironically, inflation has been very contained for all of 2016 without any interest rate hikes. In face, inflation during 2016, even without a single interest rate increase, has been so low that the formula for Social Security benefits means that there well be no cost of living increase.
That makes you wonder why the Fed has been so eager to raise rates, if the whole point of an interest rate increase is to hold back inflation, when there was no inflation at all.
There still isn’t any inflation, but the Fed wants to raise rates for other reasons. One that keeps getting floated around is the idea that while it hasn’t been hot, the U.S. economy has been expanding over the last several years. The way economic cycles work, that means that sooner or later, a contraction will occur. If the Fed still has interest rates sitting at zero, then that means they have no ability to cut rate to help stimulate the economy.
Moving forward, the Fed continues to predict an average of 2% GDP growth over the next three years. It also now has added an additional rate hike to its so-called “dot plot” showing that they now anticipate three rate hikes during 2017, instead of 2016.
Of course, a lot of things are changing next year, starting with the U.S. Presidency, so predictions are shaky at best moving forward.
The important thing is that the Federal Reserve finally got the interest rate hike they so desperately wanted for 2016. Now, they have a little breathing room to maybe sit back and do what is best for the economy, instead of focusing on executing a preconceived move.
Market Reacts to Fed News
While literally every financially literate person in the world knew the Fed was planning to increase interest rates today, the talk of an additional rate hike in 2017 was less expected. As a result, the stock market decided to take a break from its streak of record setting sessions. The Dow closed down 118.8 points, or 0.6 percent on the day.
After an almost non-stop rally since November, I wouldn’t be surprised to see the markets use this news as an excuse to take a breather. Look for at least a few volatile days moving forward, until the next “big” news story tells the markets which we to go.
Will the Fed’s actions affect the chance for a Santa Claus rally? We’ll have to wait and see.