CNN reports that it’s “all but certain” that the Federal Reserve will lift interest rates this week. Raising rates faster than planned is a solid indication that the economy is headed in the right direction, but it nevertheless could have some significant side effects for the stock market.
Let’s take a look at what this could mean for the economy’s continued growth in the future.
Interest Rates at Record Lows
In 2008, the Federal Reserve cut interest rates down to historic levels. Since then, interest rates have been kept at these record lows as a way to stimulate the economy.
Interest rates decreases are common during a recession; cheap lending makes it easier for businesses to grow and for individuals to thrive. Unfortunately, this can have a negative impact in a more successful economy, where lower interest rates can compel individuals and businesses to take on more debt than is prudent, ultimately leading to runaway lending.
Cheap money has been driving many stock increases, as investors have had more cash to burn. With interest rates increasing, however, many worry the stock market could tank. If there is a bubble in the market, this could potentially spiral into a more significant crash.
Rate Hikes Are Inevitable
Though a rate hike has not yet been announced, it’s seen as inevitable. It’s likely that there will be three or four rate hikes throughout the year, making it more expensive to borrow money and more difficult to invest. The severity of this is only known by the Federal Reserve.
Ideally, rate hikes should occur slowly, and should be done in very small increments to avoid “shocking” the system. This has been seen in Canada recently, which has undergone several interest rate increases in the past year, and has declined to increase rates further until it sees how these chances ultimately pan out. Four interest rate increases rather than three interest rate increases could potentially have a damaging impact.
In the last two years, the Federal Reserve has raised rates by 1.25%. Comparatively, rates were raised by 4.25% between 2004 and 2006. Due to the disparity in these situations, it’s difficult for analysts to predict the Fed’s actions at this time. If there are four rate hikes throughout the year, the interest rates will likely be at 2.25% to 2.5% by the end of the year.
It’s important to note that this is still a historical low. Interest rates were over 5% throughout the majority of the 1990’s. However, many Americans have become used to artificially low interest rates in the past ten years.
The Impact of Hikes on Investors
Interest rate hikes aren’t bad for everyone; they’re exceptionally good for the boomers. Older generations have a tendency to invest in bonds and certificates of deposit, both of which are directly correlated to the Federal Reserve interest rates. Cutting interest rates may have boosted the stock market, but they significantly reduced the return for these lower risk investments. With the new interest rate hikes, many people will be making more money on bonds and CDs and less money on the stock market.
On the other end, interest rate hikes are going to make it more expensive to borrow money overall. Everything from home loans to automobile loans are going to become more expensive, which can lead to Americans taking on less debt and spending less money in general. Interest rate hikes will extend from personal to commercial loans, potentially stifling small business.
Interest rate hikes are a fairly delicate balancing act, as failing to raise rates can lead to an overheated boom-and-bust economy. Likewise, raising rates too fast can panic investors and slow down the economy, potentially leading to a crash. The Federal Reserve will need to raise interest rates slowly but carefully to avoid any major upset, and that does not guarantee that a major upset won’t happen.
As of now, many analysts are waiting to hear from the Federal Reserve before they make any strong predictions or change their positions. Whether interest rate hikes are raised (and by how much they are raised) will have a substantial impact on investments in the months to come.
Regards,
Ethan Warrick
Editor
Wealth Authority
