Practical analysis for investment professionals
05 November 2015

Fed Watch: Preparing for Liftoff

Posted In: Economics

It has been nearly a decade since the US Federal Reserve last raised its federal funds rate, which may help to explain the apprehension among financial market participants who wonder how markets will react when the Fed finally decides to move its benchmark rate up from the current 0% to 0.25% range.

In March of this year, Fed Chair Janet Yellen first opened the door to the idea of a rate increase with the subtle deletion of a pledge to be “patient” with respect to a future rate hike from the Fed’s official statement. In recent months, however, slowing growth overseas, particularly in China, and a strong dollar have proven to be significant headwinds for US manufacturers. Over the same period, jobs data has been disappointing. As a result, monetary policy has remained unchanged, but Fed watchers took notice of the central bank’s press release following its October Federal Open Market Committee (FOMC) meeting.

The key passage in the release stated:

“In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress — both realized and expected — toward its objectives of maximum employment and 2 percent inflation.”

JP Morgan economist Michael Feroli pointed out that this was the first Fed statement since 1999 that mentioned a potential rate increase at the next meeting, and many observers interpreted this as a signal to the markets. The next FOMC meeting is on December 15–16, and futures contracts now imply a roughly 56% probability of a December rate hike, up from 34% prior to the Fed statement. All eyes will be on the final two monthly employment reports coming out before next month’s Fed meeting, as they will likely factor heavily into the Fed’s decision.

Earlier this week, we asked CFA Institute Financial NewsBrief readers when they expect the Fed to hike interest rates.

When do you expect the US Federal Reserve to raise interest rates?

When do you expect the US Federal Reserve to raise interest rates?

Not surprisingly, opinions were divided. A plurality (39%) of the 796 respondents to our poll, expect the Fed to raise rates in the first half of 2016, while 37% don’t think the Fed will wait that long and will pull the trigger in December. Another 11% of respondents think the Fed will hold off until the second half of 2016 before pushing rates higher, and 13% don’t see rates going up before 2017.

Why does all this matter? The influence of Fed policy on financial market returns has been well-documented, so it behooves investors to know which way the monetary policy wind is blowing. And for those who believe the Fed’s zero-interest rate policy (ZIRP) — which has punished savers, pushed investors into risky assets, and increased leverage since 2008 — has overstayed its welcome, a rate hike will mark a return to normalcy of sorts.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
David Larrabee, CFA

David Larrabee, CFA, was director of member and corporate products at CFA Institute and served as the subject matter expert in portfolio management and equity investments. Previously, he spent two decades in the asset management industry as a portfolio manager and analyst. He holds a BA in economics from Colgate University and an MBA in finance from Fordham University. Topical Expertise: Equity Investments · Portfolio Management

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