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Fed Fails To Shock

0322_Fed

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What's going on?

The US Federal Reserve (“the Fed”) once again raised its target interest rate – and all investors did was shrug!

What does this mean?

It was widely expected that the Fed would raise interest rates (by 0.25%, to a range of between 1.5%-1.75%), which is partly why investors were so unfussed. The Fed’s committee members suggested that they expect interest rates to go up a touch faster than they’d previously thought, which could have been taken as a signal that the Fed will quicken its pace of interest rate hikes. However, the Fed’s new chairman later downplayed the importance of these projections – leaving investors’ expectations for future interest rate rises broadly unchanged on the day.

Why should I care?

For markets: Not much to see here… for now.

Investors initially reacted as if interest rates were expected to go up more quickly, but those moves largely reversed following the Fed Chairman’s comments, leaving both stocks and bonds back where they were at breakfast time. Interestingly, the US dollar fell in value, suggesting investors may have expected a more definitive signal that the Fed would raise its interest rate more quickly (generally investors buy currencies when they think they will get paid a higher interest rate – more on that here).


The bigger picture: There’s a disconnect between the Fed’s projections and what the bond market is implying.

The Fed’s current projections suggest its target interest rate will rise 0.75-1% this year and about the same again next year. This is a fairly rapid pace – at least relative to the past decade. So why is a US government bond that expires in 10 years still only paying investors less than 3% annual interest? It seems that either the Fed’s interest rate won’t meet its own projections – or that US government bonds will have to sell off further in order to offer a higher rate of interest, a.k.a. yield (how does that work? Click here).

Originally posted as part of the Finimize daily email.

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