What is this I hear about interest rates?
Unless you have been hiding under a rock, you have most likely heard that Janet Yellen and the Fed have been contemplating an interest rate hike for quite some time. Why haven’t they pulled the trigger and what are the implications of raising rates? Before we dive into these two questions, let’s rewind the clock and briefly review how we got here.
As most investors recall, the financial collapse of 2008 was a terrifying uncertain time for the economy. Fears quickly resurrect headlines such as the “leverage crisis”, “housing bubble”, and “the worst recession since the Great Depression” just to name a few. In an attempt to stimulate the economy, the Federal Reserve lowered short-term interest rates down to 0%. Seven years later, (time flies when you’re earning nothing on cash I guess) global economies remain fragile and are chugging along at a slow pace.
The statutory objectives of the Fed are maximum employment, stable prices, and moderate long-term interest rates. Unemployment is currently at its lowest rate in seven years and inflation is below 2%. So why has the Fed hesitated? 2015 delivered mixed economic data; notably wage growth and retail sales numbers have been weak. Despite this lack of consistent economic growth, many economists are still predicting the first rate hike either in June or September of this year.
During a period of rising rates, the cost of servicing existing debt along with borrowing new money becomes more expensive. Therefore, a tighter money policy during a delicate time could cause the economy to fall into a recession.
Here’s some food for thought: There have been three cycles of rising rates since 1997, with the last being June of 2006. Surprisingly, the U.S. Stock market reacted in a positive way during each cycle.
April 1997 – 12-month change in the S&P from the start of tightening was 45.5%*
July 1999 – 12-month change in the S&P from the start of tightening was 6.0%*
June 2006 – 12-month change in the S&P from the start of tightening was 6.3%*
I hesitate to predict that this trend will continue, but history shows that a rising rate environment does not mean certain doom for equities.Why should the Fed raise rates now?
Higher interest rates can provide the Fed the ability to take action if the economy were to seriously falter in the future. Secondly, the longer they wait, the greater the probability of a disastrous asset bubble. Finally, the Fed would be signaling that the economy is on a sustainable trajectory, which should instill confidence in investors.
Gregory Yocum, CFP ®
Partner, ARQ Wealth Advisors, LLC