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Fed Raises Short-Term Rates for First Time in a Year as Dow Flirts with 20,000

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After going a year since its last rate increase, the Federal Reserve surprised almost no one by announcing this week that it was raising the benchmark federal funds rate by a quarter percentage point—to between 0.50% and 0.75%—and that officials now expect to raise short-term rates more often in 2017. That it has been a year between rate hikes is probably, for most, the bigger surprise. Furthermore, this is only the second interest rate increase in more than 10 years.

The decision to increase the federal funds rate was unanimous, and the Federal Open Market Committee (FOMC) now forecasts three rate hikes for 2017. In her post-meeting press conference, Fed chair Janet Yellen admitted that Donald Trump’s election win impacted the central bank’s calculations while adding, “all the FOMC participants recognize that there is considerable uncertainty about how economic policies may change, and what effect they will have on the economy.”

In the aftermath of the Fed’s rate increase announcement, the U.S. dollar rose to 14-year highs. The announcement also snapped the seven-day winning streak of the Dow Jones industrial average as it continues to march toward the 20,000 level.

The U.S. dollar has risen sharply since the U.S. presidential election, and this week’s Federal Reserve interest rate increase gave the dollar an additional boost. The impact of a stronger dollar includes the hampering of earnings of U.S. companies that sell goods overseas. The sales and earnings that these foreign sales generate must be translated back to U.S. dollars, and a strong dollar relative to foreign currencies lowers their value. However, a stronger dollar increases the purchasing power of U.S. consumers by making foreign travel and imported products cheaper.

So how should investors proceed? As Charles Rotblut, editor of the AAII Journal points out in the Investor Update this week, we may not want to place too much faith in the estimates that come from the Fed. Following last December’s rate hike, most committee members were forecasting interest rates to be above 1.0% by now. Wednesday’s FOMC announcement raised rates to a range of just 0.50% to 0.75%.

It is best for investors to operate from a long-term plan. Charles also warns that trying to place bets based on what you think is going to happen in the short term exposes you to possible tactical errors. Such errors can be far more damaging to your wealth than any short-term drag caused by your long-term strategy not being optimal for the prevailing environment. It is important to remember that long-term investing is a marathon, not a sprint.

Wayne A. Thorp, CFA
Senior Financial Analyst, AAII
SSR Investment Committee

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