The Fed’s Rate Hike Today – Read Between the Lines
Many people were surprised today that the market went up on a rate hike increase. News outlets joked about how things have changed nowadays – when in the past a rate hike would send the market falling.
The market went up today largely because the Fed didn’t pull any surprises. That’s the easy part.
However we must look between the lines at what’s going on.
Today Yellen made a familiar comment, as quoted:
“Today's decision also reflects our view that waiting too long to scale back some accommodation could potentially require us to raise rates rapidly some time down the road, which in turn could risk disrupting financial markets and pushing the economy into recession.”
Yellen is known as a dove, yet she continues making this statement and many people either ignore or miss the point.
The truth of the matter is that Yellen has been continually warning us that low interest rates (aka “accommodation”) has been going on far too long. For the past 8 years the stock market has been propped up with a combination of 0% interest rates and the Fed purchasing treasury securities, accumulating over $4 trillion of assets.
Most investors have become so comfortable of the recent “norm” that they have lost sight of the drastic effect that the Fed has impacted the stock market over the past 8 years.
Take a look at the S&P 500 historical prices as an example. We know that prices are expected to trend upwards over time due to inflation and earnings growth. However “trend” is the key word. The movements we’ve seen over the past 8 years has not been a trend, but an artificial spike.
Yellen has been subtly warning us that the U.S. is in a risky position.
The Fed was given two tasks after 2008: reduce unemployment while stabilizing inflation (two factors that can sometimes oppose each other). Because the economy has not recovered fast enough since 2008, the Fed couldn’t justifiably raise rates in prior years. However keeping rates low for such a long time has exposed a different risk upon itself. Catch-22.
If we took the current economy, with its current GDP growth and employment metrics, and backed up 6 years… would the Fed be raising rates as it’s doing now? The answer is a definite NO.
I believe the Fed sees the current market optimism as a chance to dig themselves out of this hole because it may be the last chance they get. If market sentiment was low, the Fed would be much more cautious about raising rates, fearing a recession or market crash. See how the market reacted after the December 2015 rate hike, and how the Fed waited a whole year before raising them again?
Yellen, the gentle dove as she is, has given us two strong warnings. The first was the earlier quote mentioned, and the other warning was during her last congressional committee meeting - where she urged Congress to take charge of creating jobs and strengthening the economy.
It is my opinion that Yellen, in all her politeness and political correctness, wishes she could have raised rates sooner and blames Congress for falling asleep at the wheel – letting the stock market become artificially inflated through the Fed’s accommodative policies rather than of substance. Just watch her last few press conferences and read between the lines in what she’s saying.
What does this all mean? Expect frequent rate hikes as long as market sentiment stays positive. The market may continue rising during this time - however the higher it goes, the less stable it becomes. And the less stable the market becomes, the more prone it is to a significant correction at the slightest hint of negative news.
Hedge your portfolio, take small gains as they come, and keep yourself agile in this market.