Feds increase interest rate as U.S. economy strengthens

Mrs. Yellen

In a much anticipated move the Federal Reserve Bank, on Wednesday, raised the interest rate from 0.75 percent to 1 percent, citing the strong growth in the labor market, an increase in fixed business investments, and the proximity to reaching 2 percent inflation, it’s mandated goal.

In even simpler terms, “the message the Fed sent Wednesday is that nearly eight years after the Great Recession ended, the economy no longer needs the support of ultra-low borrowing rates and is healthy enough to withstand steadily tighter credit,” reported The Chicago Tribune in its coverage.

The Fed Chair, Janet Yellen, did note that as inflation creeps towards, 2 percent,  "It's a reminder 2 percent is not a ceiling on inflation, it's a target," Yellen told a news conference after the rate decision was released. "There will be some times when inflation is above 2 percent, just like it's been below 2 percent."

With characteristic understatement, she also said, “The simple message is the economy is doing well, It's performed well over the last several years. The unemployment rate has moved way down, and many more people feel optimistic about their prospects.” and  coming closely on the heels of last Friday’s Jobs Report, this was certainly true with  235,000 jobs added.

It was also a number that exceeded the expectation of most economists, as they anticipated the move by the Federal Open Markets Committee.

The strongest areas for growth were construction, manufacturing and healthcare. And, also, business and professional services, a catch all area, that many economists, are cautious about endorsing, since it can contain almost anything, including temporary staffing employment.

In that same press conference, the chair was asked about the role of the balance sheet in the management of the economy and, as The Washington Post reported, “Yellen said the committee had discussed shrinking the balance sheet but had not made any decisions. The Fed would like to have a higher benchmark interest rate and see the economy on a stronger footing before beginning to pare it back.”

This also signals that there maybe two more incremental raises coming the rest of the year, with most observers, and economists, predicting the the next one would be in June. And, still others state that 2018 might show three more raises.

As an expression of market confidence, the increase also is reflective of a rise, if not a phoenix like rise, from the ashes of 2008, of The Great Recession, it slashed and burned the U.S. economy. But, while there is rejoicing, there is also caution, because traditionally these third year increases do not bode well for the stock market.

Business Insider reminded those that cheered Wednesday’s news, that there is a traditional down side for stocks, when these increases occur, they said, "Many are familiar with the Wall Street adage '3 Steps and a Stumble,' popularized by Marty Zweig, for the tendency of stocks to sell off after the 3rd Fed rate hike in the cycle," said Nautilus Investment Research's Tom Leveroni and Shourui Tian.

"The S&P 500 has endured significantly below average results from 1 to 12 months after 3rd rate hikes in 11 events back to 1955," they wrote in a note on Tuesday. "Six (more than half) of those hikes occurred within a year of a major cyclical top for stocks (1955, 1965, 1968, 1973, 1980, 1999)." The only exception was in 2004, when stocks rallied for another three years before the Great Recession.”

“For banks, higher rates mean they are compensated more for lending. But for companies that make consumer discretionary goods, or things that aren't essential, higher borrowing costs imply that shoppers' spending habits may be reined in,  they explained.

For most consumers the change will be felt gradually, if at all, with the exception of one area - credit card debt, which is tied to the prime rate, which, in turn is linked to the fed funds rate. Greg McBride, chief analyst at Bankrate.com, noted that there is “a direct pass-through to credit card holders.”

With a typical family holding a typical balance of $17,000, and a current rate of $42.00 per year, in interest; if the fed raises the rate, even twice this year, it wall add another $85.00 annually.

Savers will not immediately see a change, but there will be a modest increase in auto loans, home equity loans, and mortgage rates, over time, but the most immediate change seen, will be in credit card debt.

Looking against the background of the increase we can see that the personal consumption price index rose to 1.9 percent in January from 2016, and the Consumer Price Index,  increased to 2.7 percent, giving a rosier picture than recently seen. And, some are seeing this as “new risks to the economic outlook appropriately balanced,” a view which gives optimism to future growth.

One cautionary note -- the GDP is well below healthy economic standards, as the Tribune noted when they said: “And while the broadest gauge of the economy's health — the gross domestic product — remains well below levels associated with a healthy economy, many analysts say they're optimistic that Trump's economic plans will accelerate growth. His proposals have lifted the confidence of business executives and offset concerns that investors might otherwise have had about the effects of Fed rate increases.”

Meanwhile, the next meeting of the FOMC will be May 2 and 3rd.