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Fed Hold Interest Rates, Market Expects December Rise

The Fed chose to maintain the target range for the federal-funds rate at 1.0% to 1.25%, despite growth in both household spending and business investment

Jim Sinegal 21 September, 2017 | 8:43AM

As expected, the Federal Reserve’s Open Market Committee (FOMC) stood firm on interest rates today and also announced that they're going to begin their balance sheet normalisation process next month. Even though inflation remains below their 2% target, they also indicated that there will be another rate increase some time in 2017, and the market seems to think that's likely to occur in December.

The Fed chose to maintain the target range for the federal-funds rate at 1% to 1.25%, despite growth in both household spending and business investment, as inflation measures remain below its 2% target.

This action is consistent with our thesis that yield curve normalisation will continue at a relatively modest pace due to a combination of trends in demographics, employment conditions, and credit demand. As long as inflation remains low, the Federal Reserve could choose to raise rates but does not need to raise rates, an important distinction, in our view. Indeed, the latest statement reveals that the FOMC expects short-term rates to “remain, for some time, below levels that are expected to prevail in the longer run.”

Morningstar analysts view has been informed by long-term rates, which also seem consistent with an extended low-rate environment. Ten-year bond rates are essentially the same as they were two years ago, despite the progress in economic measures over the past 24 months. We believe that long rates would move up more dramatically if the Fed’s current stance was too accommodative, and that current levels support our thesis that the central bank’s policy stance may be closer to neutral than many observers believe.

However, the Fed will begin the process of winding down its massive balance sheet in October. Quantitative easing has no doubt had some influence on long-term rates, and the market reaction to the upcoming reversal of policy will provide more information on the future course of rates. 

Finally, we believe bank stock prices have fully incorporated the benefits of higher interest rates, leaving little upside even if the normalisation process happens much faster than we expect. We believe banks like Wells Fargo offer better value, as the company's future depends on repair of its reputation rather than purely macro factors.



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About Author

Jim Sinegal  Jim Sinegal is the associate director of the financial team at Morningstar.

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