Second Fed Rate Hike? Much Ado About Not Very Much

Imagine this scenario: You are at the next regular board meeting at Apple, Microsoft, Tesla or some company of your choosing. As you glance down the agenda, where do you picture the discussion of the Federal Reserve’s expected interest rate hike? At the top? Somewhere near the bottom?

My guess is that it isn’t mentioned at all. The reason? The widely anticipated 25 basis point hike in the fed funds rate, whether it happens in June or, barring that, then most definitely before the labor day weekend (read: end of summer).

A June or July increase would be only the second rate rise in six months. The previous move in December—a 25 basis point hike that inched the fed funds rate to the current range of 0.25-0.50%—was the first in 10 years.

Personally, although to be clear I don’t have a vote, lean toward a small hike occurring in June and possibly another hike later in the year. The Fed’s habit is to lower rates in response to events, while it raises them according to plan. The Fed’s plan has been obvious. Recently, Federal Reserve Chair Janet Yellen said that “in the coming months, such a move would be appropriate,” given the Fed’s plan to “gradually and cautiously increase our interest rate over time.”

Those who like to worry about the Fed’s actions have voiced concerns such as what would happen to the stock market. Would higher interest rates put a damper on the economy, hurt capital-goods investment, or slow the housing market? Or maybe their concerns are more philosophical, such as whether a 25 basis point hike would be premature with inflation below the Fed’s 2 percent target. Or maybe they fret about a stagnant global economy or the outcome of the “Brexit” vote over whether Britain should leave the European Union.

All of these worries are much ado about not very much. First of all, the Fed has stated it does not want the international picture to be too much of an influence in making its decisions. (For the record, a U.S. rate hike would not be particularly constructive for the rest of the world.) Rather, the Fed is focusing on the U.S.—the driver of the world economy.

And the U.S. economy is certainly strong enough to handle one or two modest rate hikes. Employment trends are strong: the four-year moving average of unemployment claims is at the lowest rate since the 1970s. We’re starting to see signs of tightening in the labor market, with wages on the service side up about over 6 percent, year over year—albeit slightly offset by the manufacturing sector. GDP growth over the past 12 months is running at about 2 percent, which is not out of bounds from what the Fed said it needs to see in a healthy economy. Furthermore, the still-strong dollar will likely become a tailwind for the U.S. economy as the rest of the world bottoms out (We’re seeing signs of green shoots in Europe, and Latin America has probably troughed.) and the dollar continues to stabilize.

Beyond these statistics, the bigger reason a rate hike of 25 or even 50 basis points won’t hurt the economy is it will remove uncertainty. For consumers, knowing where rates are likely to be over the next six to eight months helps them make decisions about such big-ticket purchases as a home or a car. Corporations do better with rate certainty as does the overall stock market.

Take away the uncertainty of rates, growth and elections and you have a support beam in the market that may be the catalyst for a surprise!!

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