By: Dividend Sensei
Every six weeks the Fed’s Open Market Committee or FOMC meets and its 15 members decide what to do with America’s monetary policy. Because of the importance of interest rates and the power they hold over global financial markets (and our wallets) people understandably hang on the Fed’s every word about its forecast for the economy and future interest rate plans. Here are the four most important facts you need to know about what the Fed just did, plans to do, and most importantly how it’s going to affect your finances, the stock market, and the economy.
1. What The Fed’s Latest Economic/Interest Rate Outlook
The Federal Reserve was created by Congress in 1913 to oversee the nation’s monetary policy and put an end to the wild financial panics that frequently had devastated the US economy. Today the Fed has a dual mandate of price stability (low inflation) and full employment. This means the Fed targets a symmetrical 2.0% core inflation rate via a metric called the core Personal Consumption Expenditure or PCE index. The fed has stated that it’s willing to allow inflation to remain in a range of approximately 1.5% to 2.5%. Today core PCE is 1.8%. Full employment is the rate of U3 employment (the headline rate we see reported) that it believes represents the level below which an overheated job market will cause wages to rise too quickly (above 4%) and trigger inflation. The Fed’s current estimate for full employment is 4.5% (today it’s 3.8%).
The Fed has two main tools to achieve its goals: the fed funds rate and its balance sheet (how much mortgage based bonds and US treasuries it holds). The Fed is currently accelerating the rate at which it’s allowing maturing bonds to roll off its balance sheet (by not reinvesting the proceeds into new ones). As for the Fed funds rate this is the overnight interbank lending rate which banks charge each other to provide very short-term liquidity. The Fed funds rate or FFR is what was just raised 0.25% to a range of 1.75% to 2.0%. The reason the Fed is raising the FFR is because it wants to normalize interest rates after keeping them near zero between 2009 and 2015. Specifically this is to meet its inflation target and head off rising prices which usually accompany a strengthening economy.
As you can see from the changes in the Fed’s latest statement the FOMC is becoming more optimistic about the state of the economy. Specifically the Fed now expects 2018 US GDP growth to come in at 2.8%. That’s up from 2.7% at its March meeting and 2.5% at its December one. The Fed also expects US unemployment to hit 3.6% this year and remain there through 2020. Meanwhile it expects core PCE inflation to achieve its 2.0% mid-range target this year, 2.1% next year, and then fall back to 2.0% in 2020.
Every other meeting the Fed does a survey of its 15 voting members to see where they think interest rates will go over the next few years. Currently the consensus is for two more hikes this year, three in 2019 and one final one in 2020. This would bring the FFR to a range of 3.25% to 3.5%. In the long-term the Fed expects to lower interest rates twice to bring them to a range of 2.75% to 3.0%. Note that these dot plots change over time and are not a promise of what the Fed will do. It’s merely the current road map, which can and will change as economic, inflation, and labor market data does.
Ok so that’s what the Fed is saying, thinking, and projecting about the economy, inflation, and interest rates. But what does it actually mean for your wallet, portfolio, and the economy?