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4 Questions About the Fed and Interest Rates

U.S. Federal Reserve building

Economic growth has improved, driving unemployment down and increasing inflation. This has prompted the U.S. Federal Reserve (Fed) to raise short-term interest rates. But what does this mean for you as a long-term investor? We talked with Investment Strategist Brian Therien about some questions investors may have about the Fed and its connection to interest rates.

1. What is the Fed?

As the central bank of the U.S., the Fed performs several functions to promote the effective operation of the U.S. economy.

2. Why does the Fed change interest rates?

The Fed conducts the nation’s monetary policy with primary objectives of fostering maximum employment and stable prices. When unemployment is low and inflation is expected to rise above the Fed’s long-term objective of 2%, the Fed may increase rates. This typically slows economic growth to a more sustainable pace. Conversely, when unemployment is high or inflation is too low, the Fed may cut interest rates to help spur stronger economic growth. We expect the Fed to continue a slow, patient pace of short-term rate increases.

3. Does the Fed control interest rates?

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

4. What should I do?

While the Fed’s actions can cause short-term market disruptions, they shouldn’t impact your long-term goals and a properly positioned portfolio. Instead of predicting when the Fed will increase rates next, we recommend working with your financial advisor. Together, you can help ensure your portfolio is properly allocated and prepared for any additional rate increases.

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