Federal Reserve Raises Key Lending Rate
The Federal Reserve raised its key lending rate in March for the second time in three months to a range of 0.75% to 1.0%. But is the U.S. economy strong enough to support even a small rate hike? How will the U.S. economy respond if the Fed raises rates again in 2017? And could additional rates derail the second-longest bull market in U.S. history?
On March 15, Federal Reserve Chair Janet Yellen announced that it was raising its key lending rate, for just the third time in 10 years, amid encouraging economic data that shows the U.S. economy is gaining momentum and is on the road to sustained economic growth. Moreover, the Federal Reserve said it expects U.S. gross domestic product (GDP) growth of 2.1% in 2017 and 2018.1
That sounds like decent growth, but it’s only a forecast; the Federal Reserve has a history of having very optimistic projections that eventually need to be revised. Are the Fed’s 2017 and 2018 GDP projections too rosy?
During President Obama’s presidency, GDP averaged just 2.3% and was an anemic 1.6% in 2016, his last year in office. Those are weak GDP numbers for the world’s strongest economy. Especially when you consider the fact that average GDP growth before the financial crisis was above three percent.
Even the Federal Reserve itself cannot agree on the health of the U.S. economy. The New York Federal Reserve expects first quarter GDP to advance at an eye-watering 3.2% in the first quarter. U.S. GDP was just 1.9% in the fourth quarter of 2016.2
Meanwhile, the Atlanta Fed believes the U.S. economy will grow at its slowest pace in two years. Real GDP will be just 0.9% in the first quarter. In early February, the Atlanta Fed was much more optimistic and thought first quarter U.S. GDP would advance 2.7%.3
Federal Poised to Raise Rates Again in June and December
The Federal Reserve raises its lending rate in an effort to moderate growth. But the fact is that the U.S. economy is not throwing up strong GDP numbers. Why would the Fed want to raise rates in a period of slow economic growth and virtually non-existent wage growth?
Raising rates is good for those with fixed income investments, like CDs, Bonds, and Treasuries. But it’s going to hurt those with credit card debt and adjustable rate mortgages. With barely-there wage growth, it’s going to be really hard for U.S. households to pay down their debt. Today, more than half of all Americans (56%) have credit card debt of at least $15,000. At the other end of the scale, just four percent of American households are debt-free.4
If the U.S. economy was reporting strong jobs data that includes secure and well-paying jobs, maybe the U.S. economy could support the rate hikes. But it’s eight years into the U.S. economic recovery, and most of the jobs that have been created have been part-time, low-paying jobs. The official unemployment rate may be 4.7%, but the underemployment rate is near 9.5%.
In this economic climate, the Fed suggested in its March minutes that it might increase rates again in 2017. Most believe the Fed will raise rates again in June and December. What could happen if the Fed raises rates prematurely? Aside from squeezing already-financially stressed U.S. families, premature rate hikes could be the final nail in the bull market.
Is It the End of the Bull-Market?
In December 2015, the Federal Reserve raised its lending rates for the first time in a decade. The markets responded badly, and stocks plunged in early 2016 on weak U.S. economic data and fears of a global recession. Stocks rebounded.
In December 2016, the Fed raised rates again. Investors are so optimistic that Trump’s economic policies will be good for corporate America that they ignored the increase. But nothing has changed economically since President Trump came into power: the U.S. economy is still very weak. If investors don’t see strong second-quarter results and a raft of encouraging economic data roll in, stocks could experience a serious correction.
The Fed might like the strong jobs data and believe inflation is in check, but most Americans cannot find good jobs, household debt is approaching record levels, and wage growth is flat. Unwarranted rate hikes in 2017 and 2018 could make the sluggish U.S. economy stall. This would bring the geriatric, overvalued bull market to an end.
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- “Fed Raises Rates; Yellen Holds Press Conference,” The Wall Street Journal, March 15, 2017; http://www.wsj.com/livecoverage/fed-decision-yellen-march-2017.
- “Nowcasting Report,” Federal Reserve of New York, March 10, 2017; https://www.newyorkfed.org/research/policy/nowcast.
- “GDPNow,” Federal Reserve Bank of Atlanta, March 16, 2017; https://www.frbatlanta.org/cqer/research/gdpnow.aspx?panel=1.
- “Household Debt and Credit Report (Q4 2016),” Federal Reserve of New York, February 16, 2017; https://www.newyorkfed.org/microeconomics/hhdc.html.