Special to the Financial Independence Hub
Vanguard applauds the Federal Reserve’s decision to raise short-term rates by 25 basis points. It marks the beginning of the normalization for a U.S. economy, which has made considerable progress over the past six years. Very rarely (if ever) have central banks successfully exited the zero bound and quantitative easing; we believe today’s U.S. Federal Reserve will ultimately prove the first to do so.
Dovish tightening cycle expected
We expect a “dovish tightening” cycle that will likely leave the fed funds rate below the rate of trend inflation for at least a year. Specifically, our non-consensus view is that we will likely see an extended pause near 1%, regardless of the near-term outlook. Reasons for an extended pause in the fed funds rate would include slower-than-expected growth—given still-fragile global economic conditions and the self-limiting impacts of further U.S. dollar appreciation—and the need and desire for the Fed to begin tapering the size of its balance sheet.
An unequivocal positive for savers and long-term investors
As this has been a widely anticipated decision, we do not expect any material impact on financial conditions in the short term. Indeed, we view the Federal Reserve’s decision as an unequivocal positive for both long-term investors and for savers.
In our opinion, those who claim that raising rates is a “policy mistake” that may derail the U.S. recovery underappreciate the still-accommodative stance of monetary policy and the resiliency of the U.S. economy. There is little to no empirical support showing a strong and material link between a 25 basis point rate hike and future U.S. economic conditions given the still-negative real fed funds rate.
Low-rate environment is secular, not cyclical
For bond investors who fear a marked rise in long-term U.S. interest rates, we believe that the low-rate environment is secular, rather than cyclical, and that credit risk in bond portfolios may be a more important factor in 2016 than duration or interest-rate risk.