Why the Fed’s Rate Increase is Good (Not Bad) News

The Federal Reserve’s (Fed) widely anticipated decision this week to raise interest rates for the first time in nearly a decade has garnered plenty of attention, especially from those concerned over the possible negative economic impact of rate increases.

However, I think such concerns are largely misguided. In my view, the Fed made the right move for the economy and markets (even if it came a bit late). Here are five reasons why:

1. Rate Normalization Will Happen Slowly

As pointed out in a new BlackRock Bulletin on “The Fed’s New Path,” the Fed said it expects rates to stay subdued and the hiking cycle to be gradual. Indeed, I believe the Fed will raise rates in a slow manner that doesn’t excessively unsettle the economy or markets, with the gradual nature of the tightening cycle allowing markets to absorb the increases with relative ease. In short, view the hike not so much as the Fed slamming on the brakes, but more as the Fed taking its foot off the gas pedal.

Plus, there are numerous factors beyond the Fed also keeping a lid on rates, including slow economic growth, an aging population and ongoing easy monetary policies elsewhere around the world. The reality is that, by historical standards, rates are extremely low and are likely to remain so for the foreseeable future.

2. The Uncertainty is Over

Both the economy and markets benefit from greater certainty and clarity over the path of interest rates, and uncertainty over that policy path in the past year has generated a considerable amount of market turmoil. In addition, amid persistently easy policy, company leaders had a difficult time gauging the true level of U.S. economic growth, and as a result, many corporations delayed committing capital until they had more clarity. Now that we have more certainty, we could see more investment.

3. The Rate Curve Will Start Looking Normal Again

I believe a modest movement higher in short-end rates should aid the functioning of the cash and collateral markets, and it should create a bit more normalcy across the rate curve, where savers have been subsidizing borrowers for far too long.

4. Financial Markets and the Economy Look Different Today Than in the Past

Financial markets have changed a great deal since the pre-crisis period, and while firms used to finance themselves heavily at the front end of the curve (for instance, through the commercial paper market), today the back end is much more important. Thus, I believe the Fed’s articulation of a lower terminal policy rate in the longer run is much more important for the mortgage markets and for corporate capital expenditures financed through the debt markets than is a modest increase in short rates.

Additionally, the U.S. economy has dramatically changed over the past several years, with structural factors (largely the result of technological innovation and shifting demographic trends) influencing it in a manner that makes comparisons to past rate hiking cycles less relevant.

5. Excessively Low Rates Were the Bad News

Finally, many discussions of the potential negative consequences of a rate hike underplay the already existing negatives witnessed from keeping rates excessively low for too long, including delayed retirements and misallocated capital.

Above all, investors should view the rate hike for what it is: good news and a testament to a resilient U.S. economy. By many measures, the economic recovery hasn’t been a robust one, but I believe the economy has actually been doing better than many headline numbers would imply. By raising rates, the Fed is signaling its faith that the recovery can continue, even if domestic growth may have already crested while the Fed waited.

As for the implications for investors, if rate normalization is handled in the cautious manner we at BlackRock anticipate, it shouldn’t be a significant source of market volatility in the year ahead. However, further regional policy divergence, slow emerging markets growth and global liquidity risks are likely to keep market volatility higher, meaning effectively navigating a low-return world will remain a challenge.


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