Higher Interest Rates

Tuesday, December 01, 2015

If you have nothing better to do and find yourself watching CNBC, FBN, or Bloomberg prepare yourself for the non-stop chatter about interest rates and whether or not the Federal Reserve will pull the trigger in December and begin the process interest rate normalization.

The Federal Reserve holds its last meeting of the year Dec. 15-16 and all financial eyes will be waiting for the 2 p.m. announcement on the 16th.

If you remember, the markets were surprised when the Fed did not raise rates at its September meeting and, frankly, I heard a great comparison the other day by a talking head. He compared it to Lucy and Charlie Brown and her ability to take the football off the tee at the last second causing Charlie Brown to end up flat on his back.

I find it quite funny that the certainty of an interest rate hike in September was the excuse for the markets pulling back in the third quarter and now the certainty of the rate hike in December is the reason for the markets rallying from the third quarter selloff. I guess you can have your cake and eat it, too!

The bears on Wall Street still believe that Fed policy and quantitative easing was the sole cause of stock market recovery over the last several years and dismiss the massive rise in corporate earnings. The same bears now add the fear of a debt spiral that will be caused by a rise in interest rates in regards to the interest on our national debt.

The key issue on whether or not equity prices go higher from this point is an investor s appetite for risk. When investors panic and flee from risk, bond yields and stock prices both drop.

Several years into this bull market, which started when mark-to-market accounting was changed, the panic of 2008 is still receding. Every day more investors realize that the doom and gloom forecasts just have not come true and investors confidence is slowly returning.

The other issue to realize is that the coming rate hike cycle will be different from any other time in history. In past cycles the Fed was required to actually drain reserves from the banking system. However, there is currently $2.6 trillion in excess reserves and the Fed has no plans to drain them. In fact, the Fed continues to pay banks to hold excess reserves. This means that money will not be tight any time soon.

The Fed has not raised its interest rate in 10 years. The markets, both the equity and bond markets, can certainly handle the rate cycle that will begin in December. It is going to be a very slow crawl back to normal interest rates, whatever normal now means in today s world.

As always, keep calm and carry on with your disciplined approach to investing for the long term.


Wesley Lentz Wesley Lentz

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