Last week, the U.S. Federal Reserve raised interest rates again. Since December 2015, the Fed has increased the rates four times. And it expects to raise interest rates aggressively over the next two years.
In fact, as per Federal Open Market Committee (FOMC) projections, the federal funds rate (FFR)—the benchmark interest rate in the U.S., on which mortgages, business loans, credit card balances, auto loan rates, and more are based—could be above three percent by 2019. It’s only 1.25% today! (Source: “June 14, 2017: FOMC Projections materials, accessible version,” Board of Governors of the Federal Reserve System, June 14, 2017.)
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Higher Interest Rates & Business Loans
A higher FFR means a higher bank prime interest rate. You can see the sharp increase in the cost of borrowing from banks in the chart below.
(Source: “Bank Prime Loan Rate,” Federal Reserve Bank of St. Louis, last accessed June 15, 2017.)
Businesses borrow money from banks at the bank prime rate plus percentage points based on the risk assessment of the business. For example, a large public company with a solid balance sheet might borrow at the bank prime rate plus 50 basis points, for a total of 4.5%.
An average-risk business will pay prime plus one or two percentage points, so that’s a total interest rate of five percent to six percent. And, of course, higher-risk businesses will pay a lot more.
There’s no doubt: Higher interest rates will put a damper on the profitability of American companies, especially those with loans tied to the bank prime rate. And more pressure on American businesses means a weak stock market and a weak economy.
Higher Interest Rates & Stock Buybacks
We can’t forget that, since the credit crisis of 2008, large companies have borrowed money at rock-bottom interest rates. And many of those companies, if they were public, used their funds and borrowed money to buy back their own shares. In fact, about 75% of all companies on the S&P 500 bought back shares over the past two years. This action helps support their stock prices and the stock market in general.
As interest rates go up, the dollar value of stock buybacks will naturally decline.
The Low Interest Rate Party’s Over
The bottom line is that America’s addiction to low interest rates is over. The Fed is adamant about raising interest rates, and it will continue to do so. The stock market is at a record high, and the unemployment rate is at a 16-year low.
The Fed has no alternative but to raise interest rates in this economic environment. If all that money printing of the last few years leads to inflation (like I predict it will), interest rates could skyrocket.
Dear reader; in the eyes of the Fed (not in the eyes of the majority of Americans), the economic recovery is well underway, and interest rates need to rise in order to cool the economy. Higher rates will give the Fed the ammunition it needs to spur on the economy when it fizzles again.
I’ve never seen the stock market rise, nor the economy expand, after the Federal Reserve raises interest rates four times without a decrease. The Fed increased interest rates by 0.25% on December 17, 2015; December 14, 2016; March 15, 2017; and June 14 of 2017. With the Fed predicting four to six more rate increases in the next couple of years, the best days for the stock market and the economy are over.
