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As Interest Rates Rise Stocks Remain Strong

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Since the last quarter of 2015 the federal funds rate has been slowly but steadily climbing. Theoretically the stock market should become less desirable for investors to bid up if interest rates are higher because the interest rates on bonds at such a time would become more lucrative on a risk adjusted bases. But every year since the end of 2015 the S&P500 stock market index has been climbing higher. This is partly because of higher corporate earnings, and also due to a stronger economy which gives confidence to investors and consumers alike. According to a nytimes.com article, another rate hike is probably coming in December, and more are on the way for next year. “The Fed’s policy arm, the Federal Open Market Committee, last raised its benchmark rate in September, to a range of 2 percent to 2.25 percent, then left the rate unchanged at the November meeting. The central bank is widely expected to increase the rate by a quarter of a percentage point in December.”

The recent FOMC minutes which summarizes the meeting by the Federal Open Market Committee, states that nearly all committee members “expressed the view that another increase in the target range for the federal funds rate was likely to be warranted fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations. However, a few participants, while viewing further gradual increases in the target range of the federal funds rate as likely to be appropriate, expressed uncertainty about the timing of such increases.”

The good news for equity investors is that interest rates may stop climbing after next year. “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy — that is, neither speeding up nor slowing down growth,” Federal Reserve Chairman Jerome Powell told the Economic Club of New York. This was a surprise to the markets because earlier in October, Powell mentioned, in reference to the Fed’s interest rates, “we may go past neutral, but we’re a long way from neutral at this point, probably.” After his dovish remark, the Dow Jones Industrial Average climbed more than 600 points. Meanwhile the dollar slipped lower on the news. The Fed’s summary of economic projections has a range of neutral interest rate estimates between 2.5% and 3.5%. If the December hike does in fact take places then that will already bring the upper end of the Fed’s target to 2.5%, which is the low end of that neutral range.

It’s highly unlikely that the new normal for interest rates will resemble the old double-digit days of the 1980s when bank loans were prohibitively more expensive than today. There’s still a lot of uncertainty in the global economy and the aging population will limit the likeliness of fast growth and hyper inflation. Even so we have to be prepared for anything. Mortgage rates will be higher next year than last year. For home owners who bought in the recent few years but didn’t lock in a fixed rate, it may be financially prudent to pay down those debts, and curb further borrowing.

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