What the Fed’s Rate Hike Means for Municipal Bonds

The Federal Reserve announced a short-term interest rate hike on Wednesday, the first one in a year and a move that was largely expected. But what wasn’t on the radar was the Fed’s announcement that it plans to raise rates three more times in 2017, up from previous expectations of two rate hikes.

The Takeaway: The Fed’s plan to raise rates signals that economic growth is accelerating. A strengthening labor market and moderately growing economic activity were each cited as the basis for the Fed’s decision this week.

What does this mean for interest rates in the municipal market? It can be tempting to think that a rate hike will have a wide-ranging affect, but in reality it usually has a muted impact.

Variable rate debt and other short-term bonds might see a slight uptick in interest rate costs, but long-term debt issued for infrastructure projects and the like won’t see much of a change. In fact, experience has shown that a hike in short-term rates can actually cause a downward tick in long-term rates because inflation is dampened.

Long-term bonds, however, might face dangers elsewhere. Senior Moody’s Analytics Economist Dan White said this week that the anticipation of policy changes can sometimes have a more dramatic effect than the direct changes themselves.

“For example, financial markets are already beginning to price in some fiscal stimulus from the incoming administration, and that has dramatically pushed up long-term interest rates,” he told procurement consultant Onvia. “Higher long-term rates will weigh on the pace of growth as early as the first half of 2017.”

(Read more: GOVERNING.com)