The stock market’s current favorite sport is assessing the likelihood of an increase in the Federal Reserve funds rate. Every month – sometimes twice – market gurus try to read the tea leaves of the latest opaque Janet Yellen pronouncement on the state of the economy and the Fed’s approach to the benchmark interest rate. Have the markets already “priced in” an increase of a quarter of a percent? With an effective zero rate for several years now, and correspondingly low rates of inflation, what’s the real risk of a small increase?
The United States economy is churning along at a 2 percent growth rate. It’s the slowest “economic recovery” in memory. With the unemployment rate decreasing to around 5 percent, some argue that raising the discount rate will throw the economy back into recession, kill jobs and stifle growth, such as it is, by a “ripple effect” on mortgage and credit card rates. On the other hand, raising the rate now by 25 basis points might dampen the extreme market volatility we’ve seen lately and start providing people – and governments — with an incentive to save.
Right now, if a person wants to earn money on an investment, he or she has little choice but to buy stocks and bet on growth. Dividend yields are generally low; bond interest rates are likewise unspectacular; and the 0.2% return on the “old reliable” bank savings account is the equivalent of putting your money in a sock. Senior citizens and others on fixed incomes lose money daily, as inflation rates (while still low) eclipse market rates of return.
Raising the rate now might likewise help the State of Delaware as it heads toward a fiscally (or, as the late Governor Tribbitt might have said, “physically”) challenging year. Higher rates of return would give our State Treasurer more investment options for the State’s funds. Any higher rate of return at this point would help Delaware earn income to achieve its legal mandate of a balanced budget.
Today, the uncertainty about Fed policy is causing the markets to “tank” again. We read that the market – similar to a British bookie – has “priced in” a 38 percent chance of a Fed rate hike in December and 47 percent in January. As markets abhor uncertainty like nature abhors a vacuum, it just makes sense to raise rates now. There may be a small short-term dip in the markets, but that seems a small price to pay in view of the higher risk of doing nothing.