Over the past year the economy has improved moderately, which has strengthened the case for a rate hike by the Federal Reserve. The Federal Reserve’s dual mandate is to foster maximum employment and price stability. This year, we have seen progress made on both fronts with the unemployment rate hovering at 4.9% (close to the Fed’s long-term projection of 4.8%) and core consumer prices up 2.3% versus a year ago.
The details of the Fed’s September meeting point to a growing probability of a December rate hike. In the meeting, three of the ten officials voted in favor of a rate hike in September. In July’s meeting, only one official voted to increase rates. The September statement asserts that near-term risks to the economic outlook are “roughly balanced.” This is the first time the Committee has used this language since before raising rates last December, which possibly indicates a future rate hike. In the “dot-plot” projections released after the September meeting, fourteen of the seventeen FOMC members predicted that the federal funds target rate will rise by at least 25 basis points this year. There are two more meetings left this year: one in November and one in December. Since the presidential election falls just six days after the Fed’s November meeting, and the meeting is not accompanied by a press conference, it is unlikely the Fed will take action then. This leaves the December meeting as the sole remaining viable option for a rate hike this year.
In addition, the Fed risks losing credibility if they postpone the next rate hike much longer. At the beginning of the year, Fed leaders projected they would raise rates four times in 2016. In the September meeting, that number was reduced to one. If they fail to increase rates at all, the Committee would risk further diminishing public confidence.
Barring any unforeseen developments, we believe the Fed is poised to raise rates in their December meeting.
A rate hike could result in the following potential effects:
1. An increase in rates on variable or adjustable rate loans. For example: credit cards, home-equity loans and lines of credit, personal loans, car loans, and adjustable-rate mortgages. Keep in mind that rates for big-ticket items such as homes and cars won’t jump overnight, so there’s no need to rush a major decision in anticipation of a hike. Any outstanding student loans, fixed-rate mortgages, and other fixed-rate loans will not be affected.
2. A rise in interest rates for savings accounts and certificates of deposits (eventually). Many banks did not change these rates after the rate hike last year, but as the Fed continues to raise rates we can expect to see savings rates begin to follow suit.
3. Elevated volatility in the financial markets, if they respond anything like after last years’ hike.
4. A rise in the dollar versus other currencies.
The above outcomes are typical following a rate hike, however, they may or may not occur in actuality. In their most recent policy statement, the Fed emphasized that they expect economic conditions to progress in a manner that will warrant only gradual increases in the fed funds rate. So if the Fed does raise rates in December, it is doubtful the increase will be substantial.
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