The Rising Interest Rate Effect in the Stock Market

After having the first increase in the short term interest rates by the Federal Reserve last month in December, many had originally speculated that we would see another increase at the start of the new year at their policy meeting that will occur later this month. However, as discussed in this article by Jon Hilsenrath in the Wall Street Journal, there are multiple indicators from December that are making many believe that the Fed will have to put their plans on hold for this month. Despite adding 292,000 new jobs in December, U.S. industrial production declined and real GDP did not meet many expectations. However, what has been getting a lot of the media’s attention as of late is the decline in the stock market.

I think that it is important to keep in mind that the economy is doing well as a whole, but what worries many is the Fed’s rising interest rate and what effect it will have on the stock market. This is the case despite the fact that the rate is still extremely low. I believe that people’s wariness of the rising Fed interest rate and the effect that it will have on the stock market is playing a more significant part in the performance of the stock market than many realize. Investors know that the interest rate is going to continue to rise, they just don’t know exactly when yet with the Federal Reserve’s tentativeness concerning the decision and what the effect will be with each increase. As the interest rate rises, bonds are going to become a larger temptation to many, both because of their increasing returns as the interest rate rises and because they are looking like a much safer investment especially with the uncertainty currently in the stock market. We have already seen an increase in yields especially in corporate bonds as the Fed’s interest rate has increased. With the return on bonds barely exceeding inflation in the past years, bonds may be making somewhat of a comeback now that interest rates are rising.  

While I do believe it is important for the Federal Reserve to evaluate its decision on whether to raise the interest rates this month or to put it off until March, they need to rely on economic indicators in their decision rather than considering the decreasing stock prices which have gotten so much attention. I believe that there will always be an aspect of uncertainty in the stock market until the interest rate becomes stable again with no immediate expectations of interest rate changes. Many are currently worried about what the impact of the Fed’s interest rate will have on the stock market and whether there will start to be a swing in demand for bonds as they become increasingly enticing, so in one way I believe the sooner the Fed’s interest rate becomes stable the sooner the stock market can return back to normal. The only way I see the uncertainty in the stock market going away completely is once the Fed has settled its interest rate. The stock market is not necessarily the best indicator of the general economy currently because of the uncertainty I have discussed. This is why I think it is more important for both the Federal Reserve, as well as the general population, to consider other economic indicators currently when evaluating the overall health of the economy (and when to raise interest rates) rather than focusing attention onto the decline in prices of the stock market.

http://www.wsj.com/articles/fed-almost-certain-to-keep-interest-rates-unchanged-at-next-meeting-1452882343