The Federal Reserve announced on Wednesday that it would not be raising interest rates in September, but signs are pointing towards a December rate hike as three Federal Reserve officials indicated their support for an immediate rate hike.
Some reporters like those at Reuters are calling the Federal Reserve’s decision “an increasingly cautious approach to future U.S. rate increases”, but no one should be surprised with the central bank’s decision. If anything, the fact that there was so much support within the Fed for a rate hike indicates that we could see more aggressive action towards raising interest rates starting this December. That is a good thing. While stocks did rise on Thursday after the Fed’s announcement, the Fed’s constant decision to keep interest rates low is leading to some unintended and problematic consequences on the market. Choosing to delay the interest rate raise to December is not a huge risk, but investors should actually be hoping that interest rates reach normal levels sooner rather than later.
Is the Economy fine or not?
The first thing to note is just why the Federal Reserve chose to keep interest rates low after all. While the U.S. economy is doing better as people are using Franklin’s income method, getting back to work and wages are rising, there is still the concern that the recent economic growth is incredibly fragile. While unemployment rates are below 5 percent, labor participation rates continue to struggle.
And while the Federal Reserve may try its best to be an apolitical body, politics is undoubtedly playing a role here. If the Fed was to raise interest rates and that led to economic turmoil, it would do so right before the November elections. Regardless of who the victor will be, the Federal Reserve may decide that it is best to keep things calm until Americans have a clearer idea what the next four years may look like and adjust their banking policy accordingly.
Unintended consequences
The desire to avoid sudden economic moves right before such a major election and concerns about the economy are reasonable justifications for the Fed’s decision not to raise interest rates. But we should not forget that the current policy of low interest rates is unusual and was brought about in response to the biggest economic crisis of the 21st century.
Unusual may have become the new usual and it is true that inflation continues not to be a serious threat. But year after year of low interest rates has brought other unintended consequences.
With interest rates this low, the Federal Reserve has discouraged both investing into bonds as well as just saving money in general. Americans have been saving money at lower rates than ever. A survey by GoBankingRates found that 69 percent of Americans had less than $1,000 in savings compared to 62 percent in 2015. Why save or invest in bonds when they barely yield anything back thanks to low interest rates?
Consequently, more and more investors are moving money into stocks, which has elevated stock prices as investors chase the companies which everyone thinks will do well. But this elevates prices beyond what is merely appropriate for a specific company and risks creating a stock market bubble. In fact, 54 percent of fund managers now believe that equities and bonds combined have become overvalued. This has caused many fund managers to move of their assets straight into cash out of fear of a bear market.
Don’t worry about rate hikes
So how should investors react to the Federal Reserve’s decision both now and over the long-term? By not over-reacting. While the Federal Reserve’s decisions are important and have caused the stock market to become overheated, there are far too many investors who place their decisions by whatever the Federal Reserve does.
By just listening to the Fed, investors have been buoyed by the bull market to just invest in hot, booming companies. This is the wrong approach to take. With stocks overvalued as they are now, it is crucial that investors look at the fundamentals of any stock before making a decision. Now is arguably the worst possible time to get caught up in a wave of emotion.
That applies just as much to fears of a rate hike as it does to any particular stock. Should the Federal Reserve choose to raise interest rates in December, there is no doubt that stocks will fall and investors will panic about how a rate hike signifies doom in the stock market and the U.S. economy. But a rate hike is not at all remotely bad. It would show that Janet Yellen actually means it when she tells us that the economic news are good, and would encourage investors to move away from stocks and towards safer investments. Low rates are not automatically good for the market, and a rate hike will not be bad. Keep that in mind as investors fret more about that possibility.