Rate Increase - Finally (12/17/2015)

The Federal Reserve Board (FRB) voted on Wednesday December 15th to raise interest rates for the first time in a long time. The new rate will be in the range of 0.25% to 0.50%. Rates have essentially been in the range of 0% to 0.15% for seven years. Those low rates were intended to help the U.S. economy. During the time of low rates: the job market came back, unemployment went down substantially, the housing market returned and earnings by corporations rebounded. This is what had been intended and therefore the FRB was very successful. During 2015 the markets around the world were waiting for the FRB to increase rates and this had a general dampening effect on the markets as the FRB did not act. The rate increase this week by the FRB appeared as a signal that the economy was doing much better and everyone could breathe again. What is going to happen going forward?

It appears to me that the employment is basically at full employment with an unemployment rate of 5% or less. Wage growth has picked up significantly. Businesses are back to controlling expenses to increase profits. The oil industry has trimmed the fat and will learn to live with the reality of low oil and gas prices. These same low prices are benefiting consumers and businesses, giving both more income to spend on other things. The rise in interest rates should benefit two particular groups: banks and retail. Banks will benefit from higher margins as loan interest rates go up. Retail will gain as consumers have more money to spend. The added take home pay of consumers will have a big positive impact on the economy.

There will be bumps as the economy adjusts to the new reality of higher rates but it will do so. By the second half of next year we are likely going to see a stronger economy than the one we are looking at today. Will this translate into higher stock prices and better interest on bonds? I think stock prices will be impacted favorably by a greater number of mergers and acquisitions, corporate repurchase of company stock, reduced expenses and higher volume of sales. If interest rates go up slowly then there will be some loss of principal on bonds but the higher interest rates should tend to offset the decline in principal. It is likely that 2016 will be a transitional year for bonds as high quality bonds will be in demand by the U.S. and International markets.

I wish each of you a Healthy and Happy New Year!

Ed Mallon

December 17, 2015