Rate Hikes - Good or Bad?

December 20, 2018

 

 

Rate hikes on the QT. Is this good or bad?

 

Hello, my name is Paul Carroll. I'm the CEO and founder of Efficient Wealth Management, a boutique wealth management firm in South Texas. Fed Chairman Powell announced a quarter percent rate hike yesterday with new band of 2.25 to 2.50%. As a result, domestic and global stock markets tumbled.

 

Was this unavoidable? From a market point of view, valuations over time, are the net present value of future income streams discounted by long term interest rates. You raise interest rates, you see markets tumble.

 

 

But was this appropriate? Is the market too hot? Only hindsight will tell us and when I say the market, I really mean the economy. The labor market. The labor market is very strong right now. It is slowing down but is it slowing enough?

 

One of the important lessons that has faded into history is what happened back in the 1970's when administrations both in Europe and the United States were dictating monetary policy to the central banks. That led to unsustainable, destructive, high interest interest rates and high inflation.

 

Paul Volcker in 1979-1980, had to break the back of inflation by driving the nation to a very severe recession but he succeeded and he reinstalled confidence and trust in the central banks.

 

Now, fast forward decades later, central banks have not lost this lesson and to them, credibility is absolutely essential to monetary stability. When an administration attracts the central bank, jaw bones changes and certainly this is not the first time this has happened since 1979, but when that happens, the central bank is somewhat compelled to respond in the affirmative. And in the affirmative means even though it's not black and white, they felt compelled to raise interest rates on this cycle.

 

This is really just part and parcel of QT, quantitative tightening. A decade of quantitative easing had to come to an end. A decade of pouring gas on the fire had to stop. So it's really not a case of if but when do these markets stabilize? When do they revalue to more reasonable multiples? And that process is happening now.

 

The good news is the yield curve though flat is not fully inverted, the economy is running on all eight cylinders, the market is revaluing, but this is no 2008 collapse. This is a much more traditional bear market and many would argue, a much overdue bear market, though these things are never pleasant.

 

It's part of the normal cyclical correction of a normally operating marketplace. There's certainly nothing to panic about.

 

We wish you the best of success in 2019. I think it's going to be a very promising year for the United States and for the globe and of course a Merry Christmas and a Happy New Year.

 

Sources:

Compton, Eric. "Rate Outlook Intact as Fed Becomes More Cautious." Morningstar, 19 Dec. 2018, https://www.morningstar.com/videos/905794/rate-outlook-intact-as-fed-becomes-more-cautious.html.

 

 
Udland, Myles. “Fed Hikes Rates, but Signals Just Two More Hikes in 2019.” Yahoo! Finance, 19 Dec. 2018, finance.yahoo.com/news/preview-feds-last-monetary-policy-announcement-2018-155802273.html.

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