Fed Watch: Where are rates headed in 2017?

Sure, president-elect Donald Trump has dominated the business headlines since Election Day. But don’t forget about the Federal Reserve or Fed chair Janet Yellen when it comes to your 2017 “what to watch” spoilers list.

The reason: rising interest rates could also move markets in 2017.

Case in point: the Standard & Poor's 500 stock index fell nearly 1% Wednesday after the Fed hiked short-term interest rates for the first time this year. The dive trimmed its gain since Election Day to 5.3% and its year-to-date advance to 10.2%.

The Fed upped borrowing costs by a quarter of a percentage point, bringing its target rate to 0.75%. Low rates have been a main driver of higher stock prices since the bull market began in 2009. The Fed also hinted that it would increase rates three more times in 2017, a quarter point each time, which would boost its key rate to 1.5%.

While rates are still low from a historical standpoint, Wall Street is bracing for the first sustained rise in rates in a decade. Long-term bond yields have also shot up recently. The 10-year Treasury yield climbed to 2.58% Wednesday, its highest level since September 2014.

“The Fed will be moving interest rates higher next year,” says David Kostin, chief U.S. equity strategist at Goldman Sachs. His firm also sees three rate hikes in 2017. Including Wednesday’s increase “that will be a total of four tightenings in 12 months, which will cause a sustained level of uncertainty.”

Market uncertainty is one thing. Stocks collapsing under the weight of a too-aggressive Fed is quite another.

Is a Fed-driven selloff a risk? If so, what are warning signs investors should look for?

“If there's a pattern of consistently rising rates from the Fed,  and if we started to see signs of inflation picking up, those things are typically not good for stocks over the long term,” says Jeff Rottinghaus, manager of T. Rowe Price U.S. Large-Cap Core Fund.

The financial pain could be worse for investors that own fixed-income investments, such as bonds, warns Gavin Baker, manager of Fidelity OTC Fund. When bond yields rise, the value of the underlying bonds fall.  

*Top strategists and money managers from Goldman Sachs, T. Rowe Price, Fidelity and Ariel Investments offered their predictions for the market when they sat down with Paste BN’s Adam Shell and Matt Krantz for our 21st annual Investment Roundtable. Check out Roundtable highlights, including stock-specific tips, on Paste BN Money on Twitter and Facebook.