Klingelhofer says that the Fed’s projections are optimistic when compared with what the markets are predicting.
“The biggest disconnect between the markets and the Fed is that the dot points didn’t move,” Klingelhofer says. “The word ’gradual’ did appear, but the Fed is still on target for four rate hikes next year while the market has priced in two, and at some point those projections have to merge.”
In its announcement, the Fed said that economic conditions were likely to support “only gradual increases in the federal funds rate,” and that the rate is likely to remain below its eventual target “for some time,” plotting increases of approximately one percentage point a year through 2019, when it projects rates will reach 3.3 percent, well below the 2006 peak of 5.5 percent.
Wood says the projected increases should be taken as a bullish statement on the economy, not necessarily a realistic path towards normalization.
“Giving the dot-plot shows that the Fed believes, and it was unanimous, that the economy is sufficiently strong, inflation is sufficiently stable, financial markets are sufficiently stable and that normal is the appropriate policy,” says Wood. “Saying it gets the market to believe in it, and by believing it it happens. If investors believe in and behave in accordance with their paradigm, it is a real paradigm.”
Beck says advisors should tell their clients not to bank on major changes in the short term.
“If you are expecting a sharp rate increase, you’re going to be disappointed, and if you’re expecting continual rate increases, you’ll be disappointed,” Beck says. “This is a dovish fed that wants to make sure the economy maintains reasonable growth and that inflation increases to 2 percent.”
Investors need to be educated that in the current environment, the decision to raise rates indicates economic optimism, says Ragan.
“They keep saying that future rate hikes will be data dependent, so we wouldn’t expect more hikes unless the economy is growing to support them,” Ragan says. “That means there’s still a good environment for U.S. companies and the stock market. We’ll be telling investors to stay invested and take advantage of pullbacks to build quality portfolios.”