As published in the Star Tribune 9/17/16.
“When will the Federal Reserve raise interest rates?” It’s the trillion dollar question that looms over the U.S. economy. For investors, it’s the wrong question.
Nine months after the Fed ended seven years of zero-rate policy with a quarter-point hike, we’re still obsessing over the timing. But it’s not when the Fed raises rates that matters most. Rather, it’s the speed and frequency of subsequent increases that will have the greatest effect on your portfolio.
Fed Chairwoman Janet Yellen learned this lesson the hard way earlier this year. She made it clear, if not official, that the December 2015 hike would be the first of multiple increases in the ensuing 12 months.
Six weeks after the announcement, the S&P 500 had suffered its worst January ever and investors were in panic mode. Other factors contributed to the sell-off, but the Fed ultimately scrapped its plans for a steady dose of quarterly hikes.
Investors should not view higher interest rates as inherently bad for stocks. Whether it happens before the end of the year or in 2017, a “one-and-done” rate increase from the Fed could provide a favorable environment for stocks: a U.S. economy strong enough to justify higher interest rates, but a small enough increase to prevent stifling growth. Yellen understands this and will likely amend the Fed’s strategy this time around.
It is true that higher rates reflect less economic stimulus, which is understandably scary considering the significant role central banks have played since the Great Recession. But tighter monetary policy should also be viewed as a vote of confidence in the U.S. economy, which remains more vibrant than its global counterparts.
Investors should be mindful of the changing landscape. Financial stocks historically benefit most from a rising-rate environment, while yield-heavy sectors like utilities and telecoms become less attractive. Bond prices will decrease as rates go higher, which creates a headwind for bond portfolios, especially those with longer-dated maturities. The U.S. dollar could strengthen vs. other currencies and affect earnings of U.S. companies that do business globally.
A slow approach to higher rates would make those changes less severe. Given Yellen’s historically dovish approach and the knowledge that certain Fed members still oppose raising rates at all, “one-and-done” is the most likely scenario.
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