The Federal Reserve ended a two-day policy meeting this afternoon and showed a hint of optimism about the economy. After a slight contraction in the first quarter, the Fed now expects GDP growth of 2.2% in 2014, indicating a pickup during the second half of the year.
The Fed's short-term interest rate, called the federal funds rate, is projected to rise to 1.2% by the end of 2015 and 2.5% by the end of 2016, which wouldn't be the case if more growth weren't expected. When combined with another taper, bringing monthly bond purchases down to $10 billion, the easy money the Fed has provided for the economy is also slowly being shut off.
Interestingly, the Dow Jones Industrial Average (DJINDICES:^DJI) actually rose after the announcement, which isn't always the case when interest rates are projected to go up. But the Fed's policy has both good news and bad news for stock investors.
What this means for stock investors
The end of ultra-low interest rates will eventually mean that it'll be harder for companies to borrow money -- or they'll have to do so at less attractive rates. In theory, that could leave less money for investment or expansion by companies who borrow money.
But we've seen companies pull back on investment and actually hoard cash since the recession, so low interest rates are doing little to push more investment. But a higher growth rate in the U.S. could change that.
One of the reasons companies are hesitant to invest in new products and equipment is that the economy is so sluggish. Hanging on to cash is looked at as a safer use of money than risking it on new investments that may not carry high returns given the state of the economy. So, more growth or a lower level of unemployment -- the Fed predicted a rate slightly above 5% in 2016 -- could give companies a reason to invest.
That optimism is why the Dow Jones Industrial Average didn't sell off after the Fed's announcement today. It'll take time to see whether the Fed's predictions are correct, but for now a higher growth forecast is a small reason for hope.