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The Fed’s Rate Balk

By Benjamin Shepherd on March 18, 2016

While rising interest rates are generally good for growth stocks, if you own many dividend payers or bonds, rising rates can play hell with your portfolio. If like me you’re in that latter group, the Fed gave you reason to breathe a sigh of relief Wednesday.

Dividend stocks took a nose dive last summer when most of us realized it was only a matter of time before interest rates would rise. And income stocks got clobbered from the Fed’s December rate hike, and from Fed Chair Janet Yellen saying to expect four more hikes this year.

But after Wednesday’s release of the Fed’s policy decision, it became clear that the central bank was throttling back on rate hikes.

The Fed doesn’t need to raise rates to combat inflation, because there is none on the horizon. While unemployment is running at less than 5% and wages are up slightly, both of which might be considered inflationary, inflation is still well below the Fed’s 2% long-term target. Two reasons for that are low oil prices and the strong dollar making imports cheaper.

But the Fed is clearly hesitant to raise rates and risk slowing our economic growth or even tipping us into recession , especially with the global economy still weak. “Global economic and financial developments continue to pose risks,” according to a Fed statement.

With interest rates staying low, the dollar won’t strengthen much more, which is good news for American exporters. The strong dollar has made American goods a tougher sell abroad and dragged down earnings here at home, limiting potential dividend increases in some cases.

Dissension in the Ranks

Some Fed watchers say this latest decision could be a sign of dissension in the ranks, especially since some members of the Federal Open Market Committee (FOMC) were pretty vocal in their disagreement with the December rate hike.

With the current makeup of the Federal Open Market Committee and how this month’s policy vote broke down, it’s pretty clear that the December hike must have ruffled some feathers. The only dissenting vote this month came from Kansas City Fed President Esther George, a hawk who thought rates should be bumped up to between 0.5% and 0.75%. The other two hawks went along with the consensus, a good indication that they’re more concerned about a recession than letter rates stay low and possibly inflating an asset bubble.

Again, this is good news if you’re an income investor.

And it looks as though we can continue collecting our payouts from stocks and bonds without the risk of too many more rate hikes for a long time to come.  The Fed’s “dot plot,” a graph which shows each member’s projection for path of interest rates over the next three years, shows rates aren’t likely to break 1% and likely won’t hit 3% until 2018 at the earliest. Granted that could change, but that’s the current Fed thinking.

So all in all, Yellen backing off the pace of rate hikes to help the economy is good news for income investors. Given that, let’s just allow her to pretend the December hike just didn’t happen.

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