The Independent Market Observer

Fed’s More Hawkish Outlook Surprises Markets

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Dec 15, 2016 3:04:18 PM

and tagged In the News

Leave a comment

FedThe outcome of this week’s Federal Reserve meeting was as everyone had expected: the Fed raised short-term rates by 25 basis points. The surprising part was the more hawkish tone of the surrounding commentary.

If you don’t follow this stuff regularly, here's a translation: the information the Fed released, along with Janet Yellen’s press conference, seemed to suggest that rates are likely to increase faster in the future than markets had expected. Consequently, stock markets sold off a bit, which was not a surprise, but interest rates for longer-term bonds popped up, which was.

Rates could rise at a faster clip

The real story here is that the majority of Fed committee members now expect rates to rise over the next year, as shown in the following charts. The green line tracks the committee’s average expectation for rates, and you can see the upward shift over the next two years. For the first time in a while, there’s majority support for higher rates, which suggests that the rate increase cycle really is getting under way.


Janet Yellen’s press conference reinforced this idea. She and the committee appear confident in the current economic growth level and don’t see a need for the kind of fiscal stimulus that the Trump administration has proposed. Indeed, if you look at the Fed’s growth projections, they haven’t actually moved all that much. It is quite possible that these projections represent the Fed’s plans without more stimulus. Should that stimulus happen, rate increases could well be faster. It seems safe to interpret these numbers as the lower limit of what the Fed expects.

What does this mean for investors?

Bonds: In the short term, it may mean losses as higher rates drive bond prices down. We have seen this in the past couple of weeks as markets have adjusted. Over time, though, higher rates allow reinvestment to generate better returns, so the impact can be minimal. The risks involved in trying to avoid interest rate increases can also be substantial.

Given a properly diversified bond portfolio, the effects should be small over time. We also have to remember that markets move both ways, and it is quite possible that the recent upward rate trend may very well be reversed, at least partially, over the next couple of months, which would lead bond prices back up.

Stocks: Here, it’s a bit more complicated. In theory, higher rates should mean lower stock prices, and that does happen eventually. Early in a rate increase cycle, however, higher rates are actually good for the stock market. This is because rising rates, early on, signal an improving economy, and the faster growth more than compensates for the higher rates.

This is exactly what we are seeing now, as confirmed by the Fed’s analysis and Yellen’s comments. You can see the historical relationship between market returns and interest rate increases in this chart from J.P. Morgan’s Guide to the Markets. (Note that the relationship is strongest when rates are low, as they are right now.)


Though the Fed’s rate increase—and the likely faster pace of future increases—has rattled markets a bit, the bigger picture remains positive for both bonds and stocks. Rates have jumped but may well settle back.

At this point, higher rates are actually a positive sign for both the economy and the stock market. There will no doubt be more turbulence ahead, but the fundamentals remain positive, and the Fed’s rate increase only ratifies that fact.

Subscribe via Email

Crash-Test Investing

Hot Topics

New Call-to-action



see all



The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.


Please review our Terms of Use

Commonwealth Financial Network®