Raising interest rates is often equated to removing the punch bowl from the stock market while the party is still going.
It raises the cost of doing business — and that’s usually not a good thing for the economy or stocks.
So the markets should tumble this Wednesday if the U.S. Federal Reserve raises rates. Right?
Not necessarily.
The U.S. economy has mounted a very slow recovery from the worst recession since the Great Depression. So the Fed has been very careful about not removing support until the U.S. is on sound fitting.
However, the Fed’s hesitancy is now starting to hurt confidence among businesses and investors.
“Keeping interest rates at zero is enforcing the idea that the U.S. economy is fragile,” said Kate Moore, chief U.S. investment strategist at JPMorgan Private Bank.
No wonder U.S. stocks fell in September after the central bank delayed a rate hike because of concerns about the slowdown in China.
That raised concerns that the central bank knew something about the health of the economy that investors didn’t. Others feared the Fed would never be able to escape easy-money mode.
“They need to prove we’re not stuck at zero,” said Moore.
Wall Street is ready
Wall Street is more than prepared for this first rate hike in nearly a decade.
Just look at December 4 when the Dow soared nearly 400 points after the government reported strong jobs growth. The strong report seemed to cement the idea of a rate hike. Good news was good news once again, as opposed to when stocks would tank on good news because of rate-hike fears.
“The Fed will have made a spectacular hash of things if they don’t hike this week,” Luke Bartholomew, an investment manager at Aberdeen Asset Management, wrote in a recent post.
Perhaps investors are finally understanding that recent rate hikes haven’t killed off bull markets in stocks. The S&P 500 actually jumped 15% during the last rate-hike cycle, which took place between 2004 and 2006.
Of course, it’s fair to point out the recent turbulence on Wall Street.
But it’s being led by the deepening crash in oil prices, which sends warning signals about the slowing global economy and hurts profits in the energy sector.
“The collapse in oil prices” is leading this negative sentiment, Russ Koesterich, BlackRock’s global chief investment strategist, wrote in a note to clients.
“An initial hike, particularly one as well-telegraphed as this one and which will still keep rates at very low levels, is not a tremendous threat,” Koesterich wrote.
The real key on Wednesday will be what Fed chair Janet Yellen says about future rate hikes.
Koesterich thinks the Fed will “go out of its way to stress that the tightening cycle will be gentle and gradual.”
If the stock market does celebrate the first rate hike in nearly a decade, look for the party to really get going in banking stocks. Higher rates make it easier for banks to profit off the difference between the rate they pay depositors on interest and they charge people for loans.