Four Rate Hikes Is No Big Deal

 

Let’s see how certain “big” news events affected stocks lately.

President Donald Trump doubled down on threats to impose tariffs on Chinese imports. Stocks took off. He then lashed out at close ally Canadian Prime Minister Justin Trudeau. Stocks did nothing. He touted great progress at his historic summit meeting with North Korean dictator Kim Jong in Singapore. Stocks sold off modestly.

Most importantly, the Federal Reserve raised the federal funds rate ¼ point Wednesday and said it was likely there were going to be four, not three, rate hikes this year. How did investors react to this “seismic” event?

Yawwwwwwwn. From Tuesday’s close through Thursday’s close, the Dow Jones Industrial Average fell a couple of hundred points and the S&P 500 has basically done nothing.

So, is the market finally free from the Fed?

The surprising answer is, in some ways, yes.

Investors and the financial media are far too obsessed with minuscule moves in interest rates, slight changes in the language of the statement from Federal Open Market Committee meetings, and different configurations in the so-called “dot plot” (FOMC voting members’ projections of where rates are going).

This is particularly true for traders and was especially acute in the late days of Ben Bernanke’s reign as Fed chair, when he phased out the Fed’s massive bond buying program (quantitative easing). The so-called “taper tantrum” roiled markets when traders reacted as if it was the end of the world, although anybody in his or her right mind would have realized the central bank couldn’t keep buying securities forever.

The same thing happened during Janet Yellen’s tenure when she began her painfully slow move to raise the federal funds rate from the 0-0.25% at which it sat for years after the financial crisis. But markets reacted so poorly to the mere prospect of higher rates that Yellen held off her first rate hike for a few months.

Now here we are after six quarter-point rate hikes and the fed funds rate is still only 1.5-1.75%. If we have two more increases in 2018, that would bring it to a mere 2-2.25%% after nearly ten years of economic recovery. During the last recovery in the mid-2000s, the fed funds rate rose as high as 5.25%–three full percentage points higher than we would be if the Fed raises rates twice more this year.

From that perspective, it makes no difference whatsoever if we have three or four rate hikes this year. The big picture is that rates are still low and still rising gradually, and that’s been true for the last couple of years. Investors have to learn to stop missing the forest for the trees.

 

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