To Raise Or Not To Raise, That Is The Question

The on again of again posture of The Federal Reserve is apparently back “on” again regarding an interest rate hike in June.  At least that is what they are signaling this week.  Apparently they are seeing enough strength in the U.S. economy to feel confident another small increase from already very low rates should not derail the economy; they are probably right.  Another reason they may be focused on normalizing rates is so they have the ability to lower rates during the next recession.  The one thing they cannot risk is a slowdown in real estate activity.  If higher rates cause a slowdown in construction, remodeling, refi and resale activity, one of the few areas of strength at present, that could be problematic for the broader economy.  Rates are probably low enough that another rate hike or two is not going to crush real estate but if it turns out the reason they are raising is to normalize rates versus respond to economic growth they may create a problem as the perception of a less accommodative environment causes a slowdown in real estate activity.  At present the futures market does not believe a rate hike is going to happen in June but that does not mean that it won’t.  There is plenty of time between now and the next meeting for data to impact the decision.

The last time The Fed raise rates back in December stocks corrected briefly.  That was the second correction.  Stocks also sold off last summer when The Fed started discussing the idea.  Late winter and into the spring stocks staged a strong rally with the S&P 500 touching on all-time highs.  Stocks have pulled back during Q1 earnings season, which is coming to a close, where results have been mixed but not a disaster.  With two recent corrections and a generally improving economy it is remarkable stocks have held up which is reason to believe there won’t be another steep correction.

If the U.S. economy has more strength than is currently realized, small rate hikes at current low levels should have little impact on economic activity.  Therefore, we would expect a recovery in earnings to materialize which should lead to higher stock prices.

The other factor that makes this particular round of market analysis more difficult than the environment that led up to the 2008 bear market is there is no obvious market threat the way the subprime market was a potential problem back then.  Sure, there are lots of possible culprits but no one central market risk that could send stocks into a bear market at least here in the U.S.  There are some who suggest the next market collapse will be sparked in Japan, China or a coffee shop in Venezuela.  It is true, most of the rest of the world is a mess.

It is interesting that Walmart reported earning this morning and the stock was up 8.6% as I wrote this note.  If the price holds it will be their best one-day gain since 2008.

Posted in Central Banks, Government Policy, Investments and tagged , , , .

Brian Dightman