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Should we fear higher interest rates, or welcome them?

27 September 2018

The Federal Reserve ("Fed") raised rates last night for the eighth time since December 2015 to a range of 2.00-2.25%. Since this cycle of rate rises began, we have seen a 50% total return from the US equities index, the S&P 500 Index. In the same period, 10-year US Treasury yields have risen from 2.26% to 3.03%. While Treasury prices have fallen, the total return from the broad treasury market has been marginally positive. By carefully preparing the market, and taking a gradual approach, the Fed has managed to raise rates without the feared disorderly sell off in bonds or a crash in equity markets. 

Last night, the focus was on the removal of the word "accommodative" from the description of monetary policy, resulting in bond yields falling. However, if anything, the so called "dot plots" that show individual members of the committee's expectations for future rates firmed up. It is expected that another rate rise in December is very likely and it is quite possible that as many as three rate rises remain on the cards for 2019. The removal of the word "accommodative" is just a reflection that they are now closer to their long-term rate expectation of 3%.

President Trump has already commented that he is not happy about the interest rate rise but also takes credit for the strong economy, which is why rates are going up. The Fed was clearly unmoved by his earlier protestations about rate rises. His tax cuts and spending plans are adding stimulus to an already strong economy, therefore as a result, the Fed is unlikely to change course in response to his words.

Gradual, well-flagged, moderate rate rises, against a strong economic background, should be welcomed, not feared. The higher rates go, the greater the ability to add stimulus should the economy get into trouble again. The Fed is currently in a stronger position than the Bank of England ("BoE") or the European Central Bank in this respect. The BoE has started to raise rates but has stated in each of its most recent Monetary Policy Committee statements that rate rises will be "gradual and to a limited extent". As long as this remains the case, rate rises should not be a problem for equity investors. If interest rates were to go back to the level seen before the financial crisis, where both US and UK rates were over 5%, then we would be more concerned. However, as it stands, the central banks on both sides of the Atlantic are currently indicating that this is unlikely.


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