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The Fed Rate Increase—Not the End of the World

The Fed Rate Increase—Not the End of the World

Ron Kelemen - Wednesday, December 14, 2016

Finally, after so much anticipation and worry, the Fed announced on December 15 that it will raise the Federal-Funds interest rate 0.25% on December 16.  That brings the rate up to 0.75%.    We view this as good news.  Why?  Because it means that the economy is doing well.   In the words of the Fed Chair Janet Yellen, “Our decision to raise rates should certainly be understood as a reflection of the confidence we have in the progress the economy has made.” The Fed is also concerned about inflation, brought about by a labor market at or near “full" employment.  The Fed anticipates three more similar hikes in 2017 if the economy continues along its current path.   


These increases will trigger higher consumer borrowing costs that are pegged to short-term rates.  However, longer term rates on mortgages and longer-term bonds may not be directly affected by the Fed.  Rather, they are more determined by supply and demand.   Because several other nations have lowered their rates and because the US economy is very strong globally, there has been a huge demand for the US dollar and debt instruments denominated by it.  The US dollar is currently at a 14-year high. This demand may keep longer-term interest rates low.  

Finally, the chart we published last year shows that it takes much more than just a 0.25% interest rate increase to derail equities into a bear market.  Based on past history, rates would need to increase by at least two-to-four full percentage points to have a major long-term effect on the stock markets.   This is not the end of the world.  As you can see by the graph above, we are still way below historic rates.  The stock market did well in the years leading up to 2007, and it’s done very well lately in anticipation of this long-awaited increase. 


 

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