Those 2017 Fed Forecasts May Prove to Be Wrong

There are two questions investors may have following yesterday’s rate hike. The first is: What happens next? The second is: What do I do now? The short answers are: Don’t put too much faith into the forecasts and enjoy the marginally higher level of interest income, but don’t make big changes. I will expound on both answers.

In regard to the first question, a bit of context is useful. Yesterday’s increase was just the second in a span of more than 10 years. As you probably recall, a 25-basis point (0.25%) increase was announced last December. What you may not remember is that the second most recent increase was announced way back on June 29, 2006. Between then and now, there has been a large number of forecasts proven to be wrong and a large number of forecasters who kept making incorrect forecasts.

Even the Federal Open Market Committee’s (FOMC) members haven’t displayed much in the way of soothsaying skills. The first chart on your right (aka, the Fed dot plot or simply “the dots”) shows last December’s target levels for the federal funds rate. Described differently, the dots represent the individual interest rate forecasts for each year. As you can see, most committee members were forecasting interest rates to be above 1.0% by now. Yesterday’s announcement raised rates to a range of just 0.50% to 0.75%. (To quote Homer Simpson, “D’oh!”) The second dot plot is the latest forecast made by FOMC members. Do you believe the committee’s crystal ball has become clearer? I don’t.

While the market has rallied since the election, there are structural issues in the economy that can’t be immediately fixed. President-elect Donald Trump’s spending and tax plans will face early tests when the debt ceiling agreement expires in March and the current spending authorization expires in April. While some regulatory changes could happen quicker, others will likely require the rewriting of rules. None of this is to say that economic growth won’t accelerate—I hope it does—but rather to say it’s not certain that growth will accelerate or by how much.

From a portfolio perspective, it’s best to stick to a long-term plan. Making changes based on what you expect to happen leaves you exposed to tactical errors. Such errors often have a far more damaging impact on your wealth than any short-term drag caused by your long-term strategy not being optimal for the prevailing environment. The hare always looks enticing, but it’s often the tortoise that does best in the realm of investing.

This isn’t to say that you shouldn’t make any changes. If you’ve loaded up on utility and consumer stocks in a quest for dividend income, diversify. Our Dividend Investing portfolio holds shares of financial, technology, travel and chemical companies, for instance. If you haven’t looked at your portfolio’s allocation in a long while, see if it is still within, say, a 5% range of your target. If you are close to retirement, build up short-term reserves from which to withdraw if you don’t have enough guaranteed income (e.g., pension, Social Security, annuity, etc.) to cover your expenses. The key thing is to make changes that will keep you on your long-term plan, and avoid making those changes based on what you think might happen.

Beyond your investments, review your savings accounts. The rate hike should boost the amount of interest paid on your cash savings, though not by much. You may realize a bigger benefit by moving your account to a bank paying a higher interest rate. For instance, Discover makes FDIC-insured savings accounts paying a little over 1% available to AAII members. A handful of other banks pay similar levels of interest rates, though just about all are online (including the aforementioned Discover account). If you prefer visiting a local branch versus banking online, call around your local area to see what’s being offered. Be sure to ensure that any bank account you open is FDIC-insured (NCUA-insured for credit unions) and the rate isn’t a teaser rate. Also beware that if the interest rate sounds too good to be true, it probably is.