Facts About the Fed and Interest Rates

May 17, 2017

Economic growth has improved, driving unemployment down and increasing inflation. This has prompted the Federal Reserve to raise short-term rates. But what does this mean for you as a long-term investor?

First things first: What is the Federal Reserve?

The Federal Reserve Bank, also known as the Fed, is the central bank of the United States. Its members meet eight times a year and work to help keep the U.S. economy running smoothly.

In general, the Federal Reserve often changes interest rates to either spur economic growth or slow the economy down. If unemployment is low and inflation is expected to rise above the Fed’s long-term objective of 2%, the Fed may decide to increase rates to prevent higher inflation and the economy from overheating. On the other hand, if unemployment is high or inflation is too low, the Fed may decide to cut interest rates to help spur stronger economic growth.

In 2017, the environment is a bit different. We expect the Fed to continue a slow, patient pace of short-term rate increases, not because the economy is overheating, but in order to get rates back to more normal levels.

What does the Fed control?

The Fed sets a target range for the short-term lending rate, which is also known as the federal funds rate. However, it typically only influences long-term interest rates. For most investors, longer-term interest rates are more important than the short-term federal funds rate.

A variety of factors – such as the outlook for economic growth and inflation, supply and demand for credit, market sentiment, and other factors beyond the Fed’s control – impact long-term rates.

The Fed has been in the news lately because it plans to reduce its holdings of longer-term government bonds. This will be a gradual process, according to the Fed, and while it could increase long-term rates, it also could be partially offset by other factors.

What should you do?

Keep in mind that while the Fed’s actions can disrupt the market in the short term, your important financial goals likely haven’t changed. Instead of predicting what the Fed will do next, visit your financial advisor  to make sure your portfolio is properly allocated and prepared for any additional rate increases.

Important information:

This information is for educational and illustrative purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. 

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk. The value of investments fluctuates, and investors can lose some or all of their principal. Diversification does not guarantee a profit or protect against loss.

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