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The Fed just raised rates. Now it’s time to pump the brakes

Janet Yellen
Pete Marovich | Bloomberg | Getty Images
Janet Yellen

The Federal Reserve's decision to raise interest rates by 25 basis points this week didn't come as much of a shock. Chairwoman Janet Yellen strongly indicated before the meeting that the hike would occur, based on promising employment numbers and building trends in inflation.

But, there's been talk of a more aggressive plan, with the potential for three to four rate hikes this year.

This would be a fairly substantial shift from the cautious Fed that has maintained a low interest rate environment for nearly a decade. And that approach could derail the gains we've made so far.

Since the financial crisis, the Federal Reserve has taken a data-driven approach to interest rate policy and has reacted appropriately to fluctuations in the economy and around the globe. Currently, business and consumer optimism in the U.S. is high, and data indicates that we are in a relatively strong position and on the right trajectory for economic growth.

While things look good domestically and certain risk levels across the globe, such as in Europe and China, are decreasing, the overall state of the global economy is still relatively uncertain. If a major economic or political event occurs abroad, capital will pour into the U.S. and drive interest rates lower.

"An aggressive plan to raise rates is predicated on achieving significant policy change in all of these areas. That seems unlikely to occur this year given the current political climate."

Stimulus plans put forth by the new administration will factor into interest rate policy as well. While the Fed is largely driven by unemployment metrics and inflation indicators, getting as many as four interest rate increases in 2017 will also depend on fiscal policy in Washington.

The current administration has touted things like tax reform, regulatory relief and greater infrastructure spending, all of which could influence interest rates. Business tax reform would provide banks with more capital, translating into more money to lend and filter into the economy; consumer tax cuts, less regulation and improved infrastructure would also serve as stimulants for economic growth.

The potential impacts these initiatives could have on the economy will certainly guide the Fed's decision-making process moving forward. However, there is still a lack of clarity around specific policy plans in these areas, and a powerful divide in Congress could potentially gridlock movement down the line.

An aggressive plan to raise rates is predicated on achieving significant policy change in all of these areas. That seems unlikely to occur this year given the current political climate.

With such a fluid environment, the Fed needs to maintain the stance it has been assuming throughout the recovery—keeping a focus on both data and fiscal policy, rather than attempting to run an economic experiment.

If the administration is able to make waves with tax reform, regulation and infrastructure, there's no question that the economy could heat up. But as history has shown, the road to significant change is a long one—and for the Fed, a more reactive than proactive approach will continue to be the right one.

Commentary by Frank Sorrentino, CEO of ConnectOne Bank, a top U.S. community bank with $4.4 billion in assets.

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