Rising Interest Rates; What Does it Mean?

The Fed raised rates again

On March 21, 2018, the Federal Reserve Board raised their target for the Fed Funds Rate by ¼ of a point.  The new target is 1.50%-1.75%. The history of the Fed Funds rate is shown in the chart above.  The gray areas are recessions.  The Fed Funds rate is the rate that banks are charged for overnight borrowings in order to meet their reserve requirements.  This was the 6th rate hike of ¼ point since the Fed started tightening in December 2015.  In a statement the Fed’s new chairman, Jerome Powell, gave a more upbeat outlook for the economy.  Powell said, “fiscal policy has become more stimulative, ongoing job gains are boosting incomes and confidence, foreign growth is on a firm trajectory, and overall financial conditions remain accommodative.”  If the economic trends stay positive, the fed has indicated that there will likely be two more hikes before the end of the year.

How does the Fed Funds rate affect me?

• First, the bad news
  Borrowing rates on common borrowing instruments are also going higher.  These include, credit cards, mortgage rates, home equity lines of credit, auto loans, and other adjustable rate loans.
• The good news
  Savings rates are also rising.  We are now seeing some 12 month CD rates creeping into the 2% range.  These are the highest rates we have seen since the end of the financial crisis in 2009.  With the GDP rate of almost 3%, the economy is continuing to grow.  Home and real estate values are rising, the stock market has been doing well, and the National Unemployment Rate is below 4%.

Higher rates and the stock market

Higher rates are bad for stocks, right?  If we look back at history, that’s just not the case.  According to a study by LPL Financial, since the early 1960’s we have seen 23 periods of rising rates.  The S&P 500 was higher in 19 out of 23 periods or 82% of the time with an average gain of 5.9% (table below). From 1995-1999, when the S&P 500 averaged over 28% per year, not only was the Fed raising interest rates, but the Fed Funds target was between 4.75% and 6.50%.
The tightening of interest rates by the Federal Reserve is definitely an indication that the bull market and economic expansion are in the later innings, but as shown in the chart below, there is most likely more room to go.