Ever since the U.S. Federal Reserve (“the Fed”) ended its latest quantitative easing program in late 2014, people from all over the world have debated when it should try to increase interest rates. It seems like every financial news outlet and economist has spent the past year discussing when a rate hike could happen and the potential impact of getting it wrong. Various forecasts and models have been used to “prove” each argued outcome of a hike—everything from rapid U.S. growth to global financial disaster. The market became so obsessed that the mere suggestion of an earlier-than-expected September hike caused market volatility to jump in August and helped pushed the S&P 500 down 10 percent in a week.
The arguments and analysis continued until December 16, when the Fed finally raised short-term interest rates for the first time in almost a decade. The world held its breath and financial markets prepared for anything. But, the day passed and nothing bad happened—almost nothing happened at all. The rate was raised and people carried on. Despite months of frenzied coverage and concern, everything was calm and average.
Why did nothing happen?
The most important thing to understand about the December rate hike is that “nothing” was the Fed’s goal. Although it was the first increase in nine years, the Fed worked hard to make it as comfortable as possible and gave people the opportunity to prepare. In fact, the Fed had so clearly signaled the hike was coming, it would have caused problems if it left the rate unchanged.
In addition to the heavy signaling and preparation time, the hike was designed to be very small. The target rate was moved from a range of 0–.25 percent up to a range of .25–.50 percent. By using these ranges, the Fed gave rates the opportunity to move closer to the new target before the actual hike took place. This allowed the real rate to change even more gradually than the official quarter-percent move.
The other important thing to recognize is that economies have momentum. It can take years to alter their courses or change how they grow. The Fed’s short-term interest rate holds a lot of power, but it’s only designed to work as an economic nudge. To influence the economy, the Fed must continuously use its short-term rate changes to reflect a consistent, long-term goal for the United States.
Staying on the same page
The Fed wasn’t the only party hoping for “nothing” from the rate hike. Banks and investors were doing everything they could to ensure a smooth transition. Changes to interest rates, even ones meant to promote economic growth, can be disastrous for those caught trading in affected markets.
Wall Street has been watching the Fed particularly closely over the past several months. Every document produced by Fed leaders was examined for details, while every economic indicator was analyzed for its impact on future interest rates. As the data came in, institutions and investors changed their market exposure for a post-hike market and, in doing so, created a market that was already adapted for the new rate.
Ultimately, the December rate hike didn’t cause any major disruptions to the market because both sides were careful. The Fed opted for a small, obvious rate hike, and the markets listened to its signals and prepared accordingly. After years of struggle to move the economy forward, no one wanted to derail the country’s progress or lose money in a needlessly chaotic market.
No one knows what the future will bring for the economy and what will happen as the Fed continues to slowly normalize interest rates, but December was an important first step. The hike proved that as long as both the Fed and markets communicate and work together, they can accomplish “nothing”—which can be a very valuable thing.
This article was written by Advicent Solutions, an entity unrelated to MFA Asset Management, LLC. The information contained in this article is not intended to be tax, investment, or legal advice, and it may not be relied on for the purpose of avoiding any tax penalties. MFA Asset Management, LLC does not provide tax or legal advice. You are encouraged to consult with your tax advisor or attorney regarding specific tax issues. ©2016 Advicent Solutions. All rights reserved.