As a little going away present for 2015, the Federal Reserve raised rates in December. Although they hadn’t been touched for many, many years, it was no surprise to economists. Now the question is, will the Fed raise rates in 2016, and if so, by how much?
Most market analysts are forming a consensus, expecting three to four hikes in 2016. Let’s discuss.
Slowly but surely the hikes will roll in
According to Tim Duy’s Fedwatch, the Federal Reserve “will to [slowly] hike rate. Economic conditions will be sufficient for the Federal Reserve to justify 100bp of rate hikes in 2016, although the Fed will not want to appear mechanical in its normalization process. Thus, they will likely find themselves hiking every other meeting beginning in March 2016.”
Duy goes on to say that the Federal Reserve will be slow to begin the process of normalizing the balance sheet. Although they will be fully engaged in that process by the middle of the year. That conversation will take on more urgency if they have difficulty controlling short rates with their new tools.
The minutes of the December FOMC meeting were released in the first week of January.
Fred Duy maps out that “regarding the medium-term outlook, inflation was projected to increase gradually as energy prices and prices of non-energy imports stabilized and the labor market strengthened.” Furthermore, comments Duy, “taking into account economic developments and the outlook for economic activity and the labor market, the Committee is now reasonably confident in its expectation that inflation would rise, over the medium term, to its 2 percent objective.”
A small move, but a hike nonetheless
According to the Federal Times the hike represents a very small move. “It will be reflected in some changes in borrowing rates. Longer term interest rates, loans that are linked to longer term interest rates, are unlikely to move very much. The impact of a single quarter-point interest rate hike is virtually inconsequential.” That said, this [hike] could be the start of a series of interest rate hikes, and the cumulative effect of those could be significant over the course of the next couple of years.
What of mortgages?
Of particular interest is mortgages. The FT points out that “the rules for mortgages are roughly the same as those for student loans: if you have a fixed rate mortgage, you needn’t worry. If you have yet to take out a mortgage but plan to do so in the future, you will receive a slightly higher rate than you would have if you had locked in your rate.”
Conversely, if you or your clients have (or are considering) an adjustable-rate mortgage, expect the rate to go up.
The Fed will remain cautious
Calculated Risk’s Bill McBride notes, “If inflation picks up, then four rate hikes is probably “in the ballpark”. If inflation stays low, then we will see fewer rate hikes.”
That’s about what our team is hearing from various sources. McBride adds, “I’ve seen several people arguing the Fed will be cutting rates by the end of 2016 – I think that is unlikely. Instead I think the Fed will be cautious – and they will not want to reverse course. Right now I think something around three rate hikes in 2016 is likely.”
It’s not just black and white
The decision to raise rates probably seems easy on paper. But actually implementing those rate is a bit more complicated. As always, taxpayers are the ones that feel the brunt of change.