Despite slow growth, Federal Reserve raises interest rates

Even though the U.S. economy only grew 1.2% in the first three months of 2017 and inflation is only 1.5% higher over the past year, the Federal Reserve, our nation’s central bank, raised short-term interest rates by 1/4 of a percentage point for a second time this year. The Federal Reserve believes the sluggish start to the year was temporary and the U.S. economy will rebound over the remainder of the year.

Simply Money Advisors believes that today's economy is much different from the one 10 to 20 years ago when economic growth of 2% would have been considered unacceptably low. Today, that is normal. Because we believe the economy will grow around this normal level of 2% in 2017, an interest rate hike was justified. This move will also allow for future support whenever the economy does begin to slow by giving the Federal Reserve the flexibility to lower interest rates.

The Federal Reserve also indicated another rate hike in 2017 is possible. The markets are skeptical though, pricing in only a 44% chance of one more hike with the most likely time being at the December Federal Reserve meeting.

While the interest rate hike last week was widely expected, the announcement of the details around the Federal Reserve’s decision to reduce its ‘balance sheet’ was unexpected by most economists. From 2008 through 2014, the Federal Reserve increased its balance sheet from $900 billion to $4.5 trillion. The Federal Reserve purchased treasury bonds and mortgage bonds to keep interest rates low and encourage economic growth. We expect its balance sheet to ultimately be reduced to around $2 to $3 trillion. Simply Money Advisors does not believe this will hurt the U.S. economy. If the economy begins to falter, it's possible the Federal Reserve will change its plans.

The Simply Money Point

The U.S. economy is not showing any signs of an approaching recession. While the Federal Reserve's plans do not stimulate economic growth, the U.S. economy is strong enough to grow on its own without the significant support the Federal Reserve has been providing. This is good for your investments because it means company earnings should continue to grow, and earnings are the most important driver of stock returns over the long run.

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