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Recent History of Federal Activity and Its Impact

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The Federal Reserve has certain economic targets that it aims to meet with its policy. To keep the economy healthy, they prefer to keep the federal funds rate in the range of 2 to 5 percent.

There have been periods when the federal funds rate has ventured outside that range.

What is considered a "healthy economy" in the eyes of the Fed? This would be where the nation's gross domestic product grows annually between 2 and 3 percent, and inflation sits around 2 percent each year. The country should also have a natural unemployment rate between 4.5 and 5 percent.

There have been several times when the Fed has taken drastic interest rate measures to either control runaway inflation or stimulate the economy. For example, in 1979 and 1980, the rate was set at 20 percent in an attempt to curb double-digit inflation. After the 2008 stock market crash, we saw the lowest rates possible (0.25 percent) to boost economic growth. Here is what we've seen from the Fed in just the past two years, their current actions, what the future holds, and how all of this activity impacts the market.

Two-Year History of Federal Reserve Activity and Its Impact

The all-time low for the federal funds rate was 0.25 percent, which is effectively zero. This was set by the Fed in December 2008, and it remained at this level for seven years until December 2015 when it was bumped up to 0.5 percent. By that time, unemployment had fallen to pre-recession levels (6 percent), with inflation trailing the 2 percent target at just 0.7 percent and GDP growth at 2.6 percent.

Interest rates remained unchanged for a year until December 2016 when the FOMC raised the federal funds rate to 0.74 percent. By the end of 2016, unemployment was down even further at just 4.6 percent. Inflation as of mid-December was 0.4 percent, and GDP growth was 3.2 percent.

Projecting steady growth in the economy, continuing strong employment figures, a robust stock market, and controlled inflation, the Fed decided to keep slowly bumping up the benchmark rate into 2017. In March, the rate was increased to 1 percent, and in June it was increased again to 1.25 percent. The FOMC met again in September but did not raise interest rates. There will be two more meetings this year, one at the end of October and another in mid-December.

When the Fed raises the benchmark rate, this may or may not have an impact on mortgage rates. Mortgage rates are set by bond investors, not the Fed, but there certainly could be an indirect effect should bond investors raise their rates. Freddie Mac reported that 30-year fixed mortgage rates increased to 3.83 percent in the third week of September, up from 3.78 percent seven weeks earlier.

When mortgage rates do change, existing borrowers with ARMs and adjustable HELOCs are affected the most. These clients may not be able to meet their obligations when their payments adjust. The good news is that refinancing to a fixed rate loan is often an option.

What the Fed is Doing Now that Could Impact the Economy

The FOMC didn't raise interest rates in September, but it still took some action that may or may not impact the economy over the next several years. After the 2008 financial crisis, the Fed built up a $4.5 trillion balance sheet loaded with bonds and other securities as a nationwide stimulus package.

Now, as a program of "normalization," the Fed is expected to start unwinding that balance sheet in October, by initially selling off $10 billion per month. These sales will escalate over the next year. According to Fed chair Janet Yellen, the process will be gradual enough that the economy shouldn't feel any effects. At the same time, she indicated that she didn't know why inflation wasn't returning to normal. Until this process is underway, we won't know what the short or long-term impact might be.

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What the Future Holds for Federal Reserve Activity

When the Fed met in September, it didn't change interest rates but did give some indications of future rate changes. Specifically, they are anticipating increasing rates once more this year and several times in 2018. In its post-meeting statement, the Fed spoke about increases in business and household spending as well as continued job growth as signs that another rate hike could be on the way. Growth estimates, however, were tamed from a previous median estimate of 3 percent to 2.8 percent.

Manage Loan Portfolio Risky with an Asset Management Company

Whether interest rates are near zero or on the upswing, there will always be some assets that perform better than others. If your company is interested in selling mortgages or is searching for a company that will buy loans from banks, consider how asset management services can help.