Every single “Fed rate pullback” has been met with buying. And stocks have consistently bounced back... and repeatedly set new highs since. Here are four reasons why you should completely ignore what the Fed does... #1 THERE ARE DIFFERENT INTEREST RATES There are lots of different interest rates... from interest rates on U.S. bonds to the interest rate you earn on your savings account. The most chatter is about bonds... Bond prices and yields move in opposite directions. So some people are worried that the Fed raising interest rates means bond prices will fall. The table above shows the current interest rate you’d earn on different maturities of U.S. government Treasury securities, depending on time to maturity... Here’s the point: None of these rates are controlled by the Fed... None.
Maturity
Interest Rate
2-year
1.3%
5-year
1.8%
10-year
2.3%
30-year
2.9%
#2 THE CHANGE IN
They’re all controlled by supply and demand. If a lot of investors want to lend for five years, they’ll buy up the bonds and the interest rate on five-year bonds will decline. The only interest rate the Fed controls is the “federal funds rate”... the rate at which banks and credit unions lend to each other on an overnight basis. Now, in theory, if the Fed raises that rate, it would hurt bonds with longer maturities (what we’d call “further out on the curve”). But in practice, this effect is miniscule. Supply and demand will determine what happens with the interest rates that affect everyday life most, not the Fed’s rate.
INTEREST RATES IS EXTRAORDINARILY SMALL When the Fed raises rates, it has been taking very small steps – say, one quarter of one percent. The Fed will then, in the future, continue to raise rates very slowly. That’s what we saw the last three times the Fed raised rates – in December 2015 and 2016 and then in March this year. A rate increase of 0.25%. Remember that prior to the financial crisis of 2008, the federal funds rate was regularly as high as 3% or 4%. So we could have about a dozen raises before we’re at “normal” levels again.
46 | June 2017
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