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Fed officials more confident about raising rates

Vanguard experts discuss what signals the Fed is watching

Fed officials have been hesitant to raise short-term interest rates. Senior Economic Strategist Andrew Patterson and Economist Alexis Gray discuss the factors likely to influence the Fed’s decision to raise rates.

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Vanguard Perspectives® 
Noni Robinson: Andrew, how likely are Fed officials to raise interest rates at the end of this year, and what data and signals are they looking for before pulling the trigger?

Andrew Patterson: So Noni, in this [September Fed] statement, more so than others, the Fed was very direct in their language about the closeness with which they came to actually raising rates this time around. They actually inserted a few sentences describing that. They had not done that in the past. And, actually, this time around you also saw three voting members of the Federal Reserve dissent, meaning they did not agree with the decision to not raise rates. Among those three included Eric Rosengren, who typically had been associated with a dovish stance, meaning he would support rates remaining lower for longer. So you can see they’re getting closer to broader acceptance of the idea that they could move going forward. In terms of data points that they’re looking for, [Fed Chair] Janet Yellen mentioned several times that they were pleased with progress made, particularly on the labor market front. She actually acknowledged that there has been a bit of a slowdown in jobs numbers. Rather than the 200,000-plus [per month] we had been seeing for the better part of the last two years, they’ve actually slowed to around 180,000. And that’s actually enough, more than enough to account for all the new entrants in the labor force. So that actually means that people are coming back. Rather than just new people entering the labor force, people are coming back that had not been there before. So, again, they’re very pleased with that. So if you were to continue to see job numbers not even at 180,000, maybe even [150,000] would be enough for them to justify a move some time in December.

Noni Robinson: And what about 2017 and beyond, should investors expect one rate hike per year going forward?

Andrew Patterson: Depending on how much credence you put in the [Fed’s] Summary of Economic Projections, and these do change over time—they’ve actually changed again—with the September release, they’ve brought down the number of expected increases in 2017 to two. It had been somewhere closer to three or four. And they’ve brought down what had been an expectation of four increases in 2018, brought that back down to three. We think in addition to that pace, it’s also very important to look out at the longer-term terminal rate. So what is the rate to which they believe they’re going to achieve “equilibrium” in the long term? That had started out as high as 4½%, and maybe even as near as two years ago; that’s come down in each one of these projections such that now it actually rests a little bit below 3%. We think that was very important to that end as well.

Alexis Gray: And I think it’s important for the markets as well that the Fed this year has lowered their expectations for how quickly interest rates will rise and where they’ll end up. One of the problems that the Fed had last December when they first raised interest rates was that they had promised to lift rates fairly quickly. And markets, I don’t think, like this very much. What we saw was that the U.S. dollar strengthened to such an extent that we saw some capital flows coming out of emerging markets. And also with that sort of aggressive pricing of interest rate hikes, that’s hurtful for any foreign countries who’ve borrowed in U.S. dollars. So I think this year if you have sort of a more steady increase expected, that that should calm the markets and we won’t see, hopefully, won’t see the sort of negative market reaction and sell-off that we had in January of this year.

Important information All investing is subject to risk, including the possible loss of the money you invest. Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. © 2016 The Vanguard Group, Inc. All rights reserved.

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