Not so fast
A rate hike in the meeting that ended on December 16 was expected by most market participants, but there were two primary questions of larger importance:
- How much will the FOMC (Federal Open Market Committee) hike rates?
- What will be the pace of future rate hikes?
On the second question, the FOMC seems quite certain that the pace of future rate hikes will be gradual. It stated as much, saying, “The federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”
The dot plot
The December meeting was one of the four in a year that are accompanied by projections on some economic variables and a projected path for the federal funds rate. The graph shown above, known as the dot plot, shows the target range of the federal funds rate as seen by FOMC members.
Of the 17 members who projected the target range, 12 believed that the rate would stand above 1% by the end of 2016. Of these 12, seven were of the opinion that the target range of the rate would be 1.3%–1.5%. All except five believed that the rate would be above 2% by the end of 2017.
What does this mean?
Assuming that the FOMC does not sharply hike rates in any particular meeting and continues at a 25 basis point hike pace, most members are indicating three to four rate hikes in 2016.
Investors in short-term debt instruments and associated mutual funds (MFGSX) (PGVAX) can be relaxed, as the rate hike has been priced in. There may be short-term volatility as markets absorb the rate hike, but anything drastic should not take place.
Investors in financials (JPM) (USB) (WFC) should be careful. Financials have not necessarily done well in a rising interest rate environment.