4 Views On The Fed’s Hike & What’s Next

We spoke to four market experts about their reaction to the Fed rate increase Wednesday and their outlook going forward.

Brian Jacobsen, chief portfolio strategist; Wells Fargo Funds Management

The Fed, as pretty much everyone expected, hiked its target rate for the federal funds rate to 0.5-0.75%. What was somewhat surprising was the Fed projecting three rate hikes in 2017 rather than two.

This is likely mainly due to the strength of the economic data we’ve seen and not wholly predicated on the prospect of fiscal stimulus coming in 2017. If it was based on the possibility of stimulus, then the dot-plot would represent a slope of hope, as there’s a lot of uncertainty around what stimulus would look like and when it would hit the economy.

The Fed will likely try to hike as slowly as possible but as quickly as necessary. The abrupt move up in yields and the dollar could dampen economic activity, and the Fed knows that. That’s why it’s going to try to do as little harm as possible, by taking it slow.

If we get a big stimulus package in 2017, the effects may not be felt until 2018 or 2019. The Fed is not trying to choke off economic growth, but the risk is that yields continue to move higher.

However, I expect this will be gradual. A gradual increase in yields from under 2% to close to 4% could take a decade and a half, much like what happened between 1945 and 1959, when the 10-year Treasury moved from 1.55% to 4.0% over the course of 14 years.

Investing in long-dated Treasurys could feel like a slow bleed. That’s why I think short-term high-yield is still the place to be in fixed income.

For equities, REITs might have attractive-enough yields to generate income, but I wouldn’t be looking for capital gains. I’d still prefer cyclical stocks over the interest-rate-sensitive defensive stocks.

Roger Aliaga-Diaz, chief economist, Americas; Vanguard

Vanguard applauds the Fed’s decision to raise rates by 25 basis points [yesterday]. And although a surprise to some, we welcome the Fed’s signal of three rate hikes in 2017. Not only did we expect this, it signals a pre-emptive move against inflationary pressures of anticipated fiscal policies. 

We’re still of the opinion that the Fed is too optimistic in its long-term projections, which remain overly aggressive. Most encouragingly, however, in a meaningful shift, the Fed was not held captive by fears of market volatility. [Yesterday’s] decision pivots to a reassuring focus on fundamentals and a move toward normalization.

Guy LeBas, chief fixed -income strategist; Janney

The Federal Reserve raised interest rates by 25 basis points to a target range of 0.50 to 0.75%, surprising precisely no one. Far more important than [yesterday’s] action was what the statement, economic projections and dot-plot all say about the future of interest rate policy in the U.S.

Our take is a slightly faster set of increases than was previously priced, and a sooner arrival at the peak of this interest rate cycle. As the December meeting is one of the big quarterly ones, we had the release of the Fed’s numerical economic projections and the dot-plot. For 2017, the median dot moved up 0.25% to 1.4%, reflecting a median expectation of three rate hikes this coming year, as well as a less-likely three hikes in 2018.

The plot underlying the dots is a simple one: If there is indeed some form of fiscal support in 2017, it’ll give monetary policymakers cover to increase rates at a marginally faster pace. It doesn’t, however, address the long-term economic ails of weak demographics, and would only marginally help slow productivity growth, so fiscal support may accelerate the pace of rate hikes, but it doesn’t much impact the stopping point of any hikes for this cycle.

We’ve seen, over the last several years, that market expectations for overnight rates tend to fall below Fed officials’ expectations. By implication, we shouldn’t see too much post-FOMC price action, since a slightly lower-than-dots outlook was already priced into current trading levels.

But the key factor to note is that the long end of the U.S. yield curve has been swinging around much more aggressively than have short rate expectations, a reversal in the last six weeks of a multiyear trend. Inflation expectations have held more sway over long rates than has the Fed, and that theme is likely to persist well into 1Q.

Broadly speaking, we’re recommending investing more conservatively in light of volatile inflation expectations. We could see longer-term interest rates—as measured by the 10-year Treasury—reach 2.75% in the first quarter of the New Year, which should present a buying opportunity for longer-term bonds.

Lindsey Piegza, chief economist; Stifel Fixed Income

As expected, the Fed opted to raise rates 25 bps from 0.50 to 0.75%, the second rate hike since liftoff in December 2015. Furthermore, the committee continues to expect a “gradual” pathway for future monetary adjustments.

Bottom line: The Federal Reserve increased interest rates as expected. The dot-plot, furthermore, showed a minimally faster pace of tightening in the near term with an expected three rate hikes next year, as opposed to two projected in September.

More importantly, however, the Fed’s longer-run outlook for growth and inflation was unadjusted, leaving the longer-term pathway for rates little changed. In other words, the Committee sees the potential for a modest uptick in prices and activity over the next 12-24 months.

But in the long run, the Fed’s forecast for a moderate (read: blah) trajectory of the economy remains. Despite the market’s more optimistic view with pro-growth policies potentially ushered in next year, the Fed expects to maintain a slow and “gradual” pace."