With a cryptic federal reserve indicating in its October minutes the potential for a year end rate hike, and once again roiling global markets, it is important to keep a grounded perspective. While a rate hike could wreak temporary havoc on bond and currency markets, and potentially, but less predictably, equity markets, there are some distinct positives that will be brought about by the anticipated rate increase.
1) 1) Reduction of market anxiety and uncertainty
There is currently a great deal of uncertainty in world markets about the path of interest rate hikes by the Federal Reserve. A small increase would put an end to some of this uncertainty, show market participants how the increase is going to play out and how it will affect their portfolios, and relieve a great deal of market anxiety.
2) 2) A rate hike could spur some economic activity
Rate hikes are in-and-of themselves a form of inflation. That is, the cost of borrowing money is going up. As such, a rate hike could spur those who may have been planning for a major purchase to go ahead and buy a house, buy a condo, or take on some other credit-financed expenditures. The realization that rates won’t be as low as they are forever can get people off the fence and encourage borrowing and spending.
3) 3) Those living off fixed income instruments could see a boost
After the initial blip caused by the rate hike itself, fixed income investors, particularly retirees who planned to live off CD and safer bond income, could see a boost as rates rise and their associated income rises. Retirees and other fixed-income investors have borne the bulk of the burden of low interest rates through this recovery. A rate hike would be the first step towards a normalized investment environment for fixed income investors.
4) 4) The Fed would get its hammer back
The Federal Reserve’s main policy tool in the event of a recession is the ability to lower interest rates. With rates essentially at zero, the Fed loses its ability to reduce them further in the event of a recessionary period. A normalization of interest rates would give the Fed back its most powerful tool.
Whether the Federal Reserve increases rates at its December meeting remains to be seen, and one thing you can count on between now and the inevitable rate hike is a great deal of uncertainty and anxiety over the eventual timing and size. It is important to stay grounded, keep a historical perspective, and focus on the long run implications of such an action.