In our recent post on interest rates, we reviewed Federal Reserve policy and explained how future Fed actions may cause interest rates to rise. Some fear that with the Fed gradually taking their “foot off the gas” by reducing the current quantitative easing program, the economy could feel some negative effects. But the question we ask is: Could gradually rising interest rates actually be a good thing for the economy and your portfolio? Here are four reasons it might.
Reason 1: Rising Interest Rates as a Vote of Confidence
In Wealth Manager Tom Wilson’s recent piece titled “Preparing Your Portfolio for Rising Interest Rates,” he mentions that the Fed’s reductions or elimination of quantitative easing would be a sign of an improving economy. This could reflect itself in rising stock prices, which could be a benefit to portfolios.
Reason 2: Rising Interest Rates Doesn’t Necessarily Mean Falling Stocks
During the 2003 – 2007 bull market, 10 Year US Treasuries bounced around a bit, but they gradually climbed from 3.82% on December 31, 2002 to 5.26% on June 12, 2007, and eventually landed at 4.04% on December 31, 20071. In addition, both the S&P 5002 and US economy3 experienced growth throughout this period.
Reason 3: Rising Interest Rates Would Make Them “More Average”
Interest rates are still at historically low levels. The 10-Year Treasury rate was 2.49% on June 30, 2013 compared to an average of 6.42% since 1958. There is still quite a gap to fill to bring rates to this historical average.
Reason 4: Banks Potentially Lend More, Spurring More Economic Activity
Rising longer-term interest rates combined with low short-term interest rates (which the Fed indicated will be until unemployment reaches 6.5%) could increase banks’ margins on loans. This in theory would encourage banks to lend more when seeking higher profits, which in turn would help economic activity and potentially benefit portfolios and the market.
What We Expect from the Fed Moving Forward?
The Fed has made it fairly clear they won’t pull back from stimulus measures unless the economy can stand on its own two legs. But even then, they aren’t likely to reverse course on monetary policy very quickly—in other words, we’re more likely to see a gradually rising interest rates than a sudden move higher.
The market and the economy have performed just fine in the past even with gradually rising interest rates. Should this be the case moving forward, it could benefit portfolios and help move you in the right direction towards achieving your longer-term goals.
Sources:
1 Federal Reserve Bank of St. Louis
2,3,4 JP Morgan Asset Management