Earlier this afternoon, the Board of Governors of the Federal Reserve unanimously voted to raise the target for the federal funds rate to a range of 0.25% to 0.50%, up from a target of 0.00% to 0.25% that had been in place since the Fed met exactly seven years ago today. The move was widely anticipated, with the futures market indicating a 76% probability of a move prior to the announcement.

In the statement accompanying the decision, the Fed noted: “The committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective.”

The Fed laid the groundwork for this move over its past few meetings by noting the improvement in labor force conditions. Unemployment has fallen from a cyclical peak of 10% in the wake of the financial crisis to a current level of 5% – a level last seen in spring 2008. Whereas concerns linger about the sluggish growth of wages and weak labor force participation, the Fed determined that current economic circumstances no longer warrant the emergency level of monetary policy that was initially established during the worst days of the last recession.

The absence of inflationary pressure has enabled the Fed to take its time in restoring more normal monetary policy, but inflation has begun to show some signs of acceleration. The Fed’s preferred measures of core inflation – which remove the more volatile effects of food and energy prices – stand at 2.0% (core CPI1) and 1.3% (PCE2 price deflator). Neither are a cause of immediate concern, but the core CPI figure in particular has begun to inch higher over the past few months. Improvement in the labor market indicates that at some point inflationary wage pressure may return as well, although there is little evidence of that at present.

We do not expect this modest increase in policy rates to disrupt the economy or financial markets, and we continue to expect that the Fed will remain patient regarding future rate increases. Elsewhere in the press release, the Fed acknowledged that “economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate” and commented that “the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run.”

The good news is that this represents the first of many steps on the long journey back toward more normal monetary policy and moves us closer to an environment in which investors will be able to earn a reasonable rate of return on traditional fixed income investments.

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1 Consumer Price Index.
2 Personal consumption expenditures.