Raising Interest Rates

Why the Federal Reserve raising interest rates is a good thing:

Now that the Federal Reserve has finally started raising the target for interest rates, many people are speculating what will happen next. They ask questions like “Will this be bad for economic growth?” or “How will investments be affected?” Let’s start by asking, “Who was surprised by this?” Most investment firms and banks have priced the market with an expectation of the Fed slowly but gradually raising the Federal Funds Rate’s target. Every source that we watched showed an expectation of a .25% raise today. Well, we got it. (If you’re not familiar with what the Fed Fund Rate is, please see the link at the bottom for a definition and brief overview.)

We believe rising interest rates will be a good long-term move for the economy, or rather it’s a good sign for the economy. Increasing the interest rates means the Fed has seen enough progression in our job markets and other areas of the economy to justify it. This is, in sense, an indication that our economy has indeed had a meaningful recovery. Another reason why this is good is when you’re on the investment side of the interest-rate spectrum (as opposed to the borrowing side) you want higher rates. Many people are frustrated by a lack of savings, CDs, and bond interest rates. They want them higher. A rise in the Federal Funds rate will ultimately have a cascading influence on those rates.

Another main reason you don’t want long-term flat interest rates is because the Federal Reserve will use interest rates to influence the growth of our economy. For example, if our economy is growing too big too fast, they will raise interest rates to slow it down to a manageable speed. On the other side, if our economy is recessionary, they will lower rates to stimulate it. Well, if we do enter a recessionary period while interest rates are flat, the Fed has less of an ability to stimulate it because rates are already so low. The Fed only has so many arrows in its quiver. The Fed already recalled one of its tools when it ended Quantitative Easing in October 2014. Rising interest rates will essentially reset another tool in the event it’s needed to ward off a recession in the future. Simply put, you don’t want the economy and markets falling when the Federal Reserve has no more tricks up its sleeve.

We actually wish they would have started raising rates back in September. Let’s quickly review what happened back then. People were speculating that the Fed would raise rates. It was a sure thing. That expectation contributed to the market pullback in August (amongst other things).

Unfortunately, when September rolled around, it seemed like the market would continue to respond negatively to a rise in interest rates. For one reason or another, the Federal Reserve decided to not raise them. The result: everyone took it as a bad sign that the Fed didn’t have enough confidence in the recovery to proceed with higher rates. The market responded negatively. It suddenly seemed we were damned if we did, damned if we didn’t. If rates were increased, it would be seen as a potential dampener on market growth, and the markets would respond negatively. If they weren’t increased, it meant our economy was still too fragile, and the markets would respond negatively. Either way it seemed like the market wanted to respond negatively.

Well here we are now. After almost a decade of historically low interest rates we finally have an increase. What will happen to the markets? We’re not 100% sure. Investment markets have a mind of their own. Perhaps the markets would have reacted negatively at first no matter what the Feds decided today. Sometimes short-term periods of volatility just happen.

One thing we want to remember is that any short-term volatility caused by this increase is just that, short term. Your investments are long-term assets. We believe the rise in rates is a good sign for investors. This rate increase was important because it simply resets the Fed’s tool box and puts us on a path to normalization. Just remember to stay focused on the big picture no matter what. Our ageless advice still stands: “Don’t make long-term decisions on short-term emotion.”

You might hear all sorts of rhetoric and predictions in the next few months. (That stuff never goes away.) We honestly believe we’re in a continued cycle of growth. Either way, successful investors have the patience and discipline to ignore negativity and continue on their path to build wealth and financial success.

One more point: The best thing about the interest rate increase is we can finally, after eight years, end the silly Wall Street obsession of when the Fed will raise rates.

We’ll be in touch as we head into the New Year. As always, thanks for being clients of Strategic Planning Group. We are humbled and grateful to have so many great clients.

Have a Merry Christmas,
Ryan Craner, John Park and Staff

Federal Funds Rate Definition:
http://www.investopedia.com/terms/f/federalfundsrate.asp?header_alt=a

These are the opinions of Ryan Craner and John Park and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice.