Vanguard comments on the historic U.S. Federal Reserve decision

Vanguard | 17 December 2015


Vanguard's Global Chief Economist Joseph H. Davis applauds the U.S. Federal Reserve's decision to raise short-term rates by 25 basis points.

"It marks the beginning of the normalisation for a U.S. economy, which has made considerable progress over the past six years. Very rarely (if ever) have central banks successfully exited the zero bound and quantitative easing; we believe today's U.S. Federal Reserve will ultimately prove the first to do so.

"We expect a 'dovish tightening' cycle that will likely leave the fed funds rate below the rate of trend inflation for at least a year. Specifically, our non-consensus view is that we will likely see an extended pause near 1%, regardless of the near-term outlook. Reasons for an extended pause in the fed funds rate would include slower-than-expected growth - given still-fragile global economic conditions and the self-limiting impacts of further U.S. dollar appreciation - and the need and desire for the Fed to begin tapering the size of its balance sheet.

"As this has been a widely anticipated decision, we do not expect any material impact on financial conditions in the short term. Indeed, we view the Federal Reserve's decision as an unequivocal positive for both long-term investors and for savers," Mr Davis said.

Vanguard Australia economist Alexis Gray
noted that while the decision by the U.S. Federal Reserve was well flagged, some volatility is expected as markets adjust to this change.

"Although interest rates have started to rise in the United States, we do not anticipate a lift in interest rates in Australia in the near term. Australia is navigating a difficult transition from mining investment-led growth to broad-based growth and will require accommodative monetary policy for some time.

"For Australian investors with a global bond portfolio, a lift in US interest rates is an unequivocal positive. Higher interest rates will result in higher nominal returns for bond portfolios over the long run, given the increase in the size of coupon payments. This will more than offset the short term capital losses that arise from the modest rate increase," Ms Gray said.

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