At the end of last week, the Federal Reserve officially ruled to increase the short-term interest rates by .25%. This wasn’t much of a shock, considering Fed officials said there would be likely three increases this year.
But as usual, investors are trying to predict how this is going to impact the economy.
Investors have been quietly panicking over the impending interest raises. Like Edson Gould’s supposed rule says, “whenever the Federal Reserve raises either the federal funds target rate, margin requirements, or reserve requirements three times without a decline, the stock market is likely to suffer a substantial, perhaps serious, setback.”
But, so far that hasn’t been the case.
“Normally, when the Fed raises short-term interest rates, it does so to tighten financial market conditions. By making it slightly more expensive for households and businesses to borrow, the Fed hopes to slow the economy modestly and prevent it from overheating, which can result in higher inflation. If successful, the Fed can preserve gains in employment while keeping inflation low and stable,” writes The Hill.
“However, following the decision to raise short-term interest rates on Wednesday, equity markets rallied, long-term Treasury yields fell and the dollar weakened (making U.S. exports less expensive). All these moves suggest it is easier for firms and households to borrow and spend today than it was before the Fed met this week. What gives? Why did financial conditions ease instead of tighten after the Fed raised interest rates?”
This is an excellent question.
Investors have been optimistic about a Trump presidency. It’s likely income taxes will decrease and more jobs will be created. These are all great things for the economy.
Federal Reserve Chair Janet Yellen has said the agency is confident in the outlook of the economy, but has been relatively vague. This is causing some financial analysts to be fearful of the impact of the rise in rates and how many there will be.
There is a real chance that there may be four increases this year, instead of the three expected. Bill Stone, chief investment strategist at PNC believes that incoming data shows a “possibility of four planned hikes in 2017.”
According to The Hill, the fed is being cautious for a reason.
“The Fed, in our view, appears to be waiting for actual evidence that inflation is rising faster — or unemployment is falling further — than it thought before telling markets it is ready to normalize more quickly,” writes The Hill. “For now, the Fed seems content to follow the plans it laid out in December.”
Author’s note: Again, the Fed increases interest rates to slow down an overheated economy and it decreases rates to stimulate the economy. However, the real problem of the current economy lies in the fact that under Obama– growth rates have been so slow that the interest rates have been effectively zero. This means that the Fed has been powerless to do anything to stimulate growth.
Trump has promised to bring the economy out of the gutter. The interest rate hike signals two things that the economy is doing well enough that they can increase it and that if the economy does turn bad, they will have some room to stimulate it– rather than being against a wall like during Obama administration. Wall Street should be happy because now the economy can be under control again.