Last Wednesday (March 21st), the Federal Reserve announced it would raise its benchmark interest rate by .25% from 1.5 to 1.75. This move was made in response to strong job gains and continued low unemployment and appears to have been well anticipated by the financial markets. In their announcement, the Federal Open Market Committee responsible for making decisions on when to hike rates and by how much, also noted what while wages have increased in recent months, overall inflation and inflation for things like food and energy have continued to come in under 2%. Given that the Federal Reserve’s mandate is to “foster maximum employment and price stability” the committee has updated their forecast to include additional rate hikes in response to a strong economic outlook.
It’s important to note that additional rate hikes are not necessarily a bad thing despite the negative connotation they seem to garner. The Federal Reserve doesn’t hike rates to be mean or cause volatility in the markets. The committee makes the decision to raise or lower rates in pursuit of the Reserve’s previously stated dual mandate of maintaining healthy employment numbers and price stability or inflation. One of their current concerns is that inflation has not naturally kept up with our recovering economy. That’s what they mean when they point out that increases in the cost of food and energy have consistently increased by less than 2%.
When we run financial plans for our clients we use a base case of 2.5% inflation or what we call a “cost of living adjustment.” Most financial planners will use a similar assumption that typically ranges from 2 to 3 percent. In an ideal world, we would see smooth and steady inflation numbers – that’s what the financial markets like. They don’t like it when we see inflation jump or “surprise.” This type of movement creates volatility. Imagine if out of nowhere the cost of everyday necessities – things like food, water, and electricity all jumped 10%. Your spending would probably feel a little chaotic. By managing the benchmark rate, the Federal Reserve Board aims to help prevent that by nudging inflation in the right direction. It’s also important to note that it is just that – a nudge. By historical standards, the pace of rate hikes has been decently slow and the hikes have been pretty gradual – typically only a quarter of a percent. As one commentary notes, “Chairman Jerome Powell pledged to ‘strike a balance’ between the risk that the economy overheats with the risk that inflation expectations fall below the Fed’s 2% longer-term target."
Here at Cedarstone, we remain diligent in tracking the Fed’s movements and the impacts those might have on our investments in addition to keeping our clients up-to-date and educated on those movements. If you’d like to learn more about the Federal Reserve’s mandate or our thoughts on the current state of the economy you can check out some of our other articles below.
Wilding, Tiffany. "Fed Outlook: Headwinds Shift to Tailwinds, But Pace of Hikes Still Gradual." PIMCO Blog. March 21, 2018. https://blog.pimco.com/en/2018/03/Fed%20Outlook%20Headwinds%20Shift%20to%20Tailwinds%20But%20Pace%20of%20Hikes%20Still%20Gradual
"Federal Reserve Issues FOMC Statement." Board of Governors of the Federal Reserve System. March 21, 2018. https://www.federalreserve.gov/newsevents/pressreleases/monetary20180321a.htm