Date: 09-Oct-2018
This is the 3rd rate hike in 2018 – and markets are predicting a 4th
“Information received since the Federal Open Market Committee met in August indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Household spending and business fixed investment have grown strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee's symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.
In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2 to 2-1/4 percent.”
-Release from the Federal Reserve dated September 26, 2018
This recent rate hike was probably the most predictable and predicted rate movement the markets have ever seen. If the Fed starts moving rates higher and faster than expected over the next year, then we will see some challenges for the stock market and consumers. But for now, that’s unlikely to happen.
So, will there be implications of this announcement? Sure. But enough to make most investors change allocations or courses of action? Probably not.
The most important tool available to the Fed is its ability to set the federal funds rate, or the prime interest rate. This is the interest paid by banks to borrow money from the Federal Reserve Bank. Interest is, basically, the cost to the banks of borrowing someone else’s money. The banks will pass on this cost to their own borrowers.
Increasing the federal funds rate reduces the supply of money by making it more expensive to obtain. Reducing the amount of money in circulation, by decreasing consumer and business spending, helps to reduce inflation.
Any increased expense for banks to borrow money has a ripple effect, which influences both individuals and businesses in their costs and plans.
Effect on individuals – Banks increase the rates that they charge to individuals to borrow money, through increases to credit card and mortgage interest rates. As a result, consumers have less money to spend and must face the effect on what they want to purchase and when to do so. In other words, mortgage rates are trending up and credit card interest rates are too. Same is true with auto loans.
Effect on business – Because consumers will have less disposable income (in theory), businesses must consider the effects to their revenues and profits. Businesses also face the effect of the greater expenses of borrowing money. As the banks make borrowing more expensive for businesses, companies are likely to reduce their spending. Less business spending and capital investment can slow the growth of the economy, decreasing business profits.
These broad interactions can play out in numerous ways.
The stock markets – This one is a bit trickier because intuitively stock prices should decrease when investors see companies reduce growth spending or make less profit. The reality, however, is that the Fed typically won’t raise rates unless they deem the economy healthy enough to withstand what should – at least in textbooks – slow the economy. But the reality is that stocks often do well in the year following an initial rate hike. But after 3 rate hikes in the same year? Much tougher to predict.
Bond Market – If the stock market declines, investors tend to view the risk of stock investments as outweighing the rewards and they will often move toward the safer bonds and Treasury bills. As a result, bond interest rates will rise, and investors will likely earn more from bonds.
Obviously, many factors affect activity in various parts of the economy. A change in interest rates, although important, is just one of those factors.
© 2018 RSW Publishing. All rights reserved. Distributed by Financial Media Exchange.
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