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Some see interest rate hikes by the Fed as a good thing


Martin Palomo

President Donald Trump raised eyebrows recently when he criticized the decision by the Federal Reserve (Fed) to raise interest rates for the second time this year. The Fed said it has raised interest rates to help prevent inflation. Sitting presidents have rarely commented on the actions of the Federal Reserve, which is supposed to be independent.

But some think the interest rate hikes are a good deal for the economy, and especially for seniors.

“The Fed is doing a dance with inflation, which is really important to a large group of constituents…retirees,” said Martin E Palomo IV, CWS, senior vice president, advisor development, Pinnacle Trust, Madison. “As the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W) rises, those on Social Security will receive a cost-of-living adjustment (COLA). The annual Social Security COLA adjustment for 2019 could top 3 percent, which would be the largest increase in seven years.”

Another important piece of inflation is wage growth. Palomo said wage growth helps combat inflation, too.

“We have seen year-over-year wage growth in more traditional lower-paying jobs increase well above the averages,” said Palomo, who serves on the investment management unit at Pinnacle Trust and is responsible for fixed income (bonds) in client portfolios. “June’s median base pay for workers in the U.S. climbed by 1.6 percent to $52,052.”

The fed hike by 25 basis points (bps) in June was in line with expectations that Fed Chairman Jerome Powell set at the beginning of the year. Palomo said the big changes in the August meetings is the language:  The Fed’s description of the economy went from “solid” in June to “strong” in August. Its description of household spending went from “picked up” to “grown strongly.”

“I fully expect we get two more rate hikes this year in September (+25 bps) and December (+25 bps),” Palomo said. “I feel like the rate hikes are a good thing for the economy and markets. The longer-term rates have not risen as much as the shorter-term rates, which means CD and short-term investors really experienced a raise in the income they receive from savings.”

The last reason he feels like the Fed rate hike is important is “to have some dry powder in the event of a mild recession. I do not feel like we will see a recession in the next 12 months, but the potential for a mild recession in late 2019 or early 2020 is there. If Jerome Powell has rates high enough before that recession, he could use another round of easing (dropping rates) to help stimulate the economy. Powell inherited a very tough job (walking a tightrope with high crosswinds), and he has done a great job so far in the way he is maneuvering. In early January, the 10-year Treasury saw a quick spike up by nearly 30 bps. The Fed of last year would have said ‘the market did a hike for us’ and reduced the number of hikes, but Powell did not miss a beat and continued on the path he set.”

Increasing interest rates by 0.25 percent is a small change, but it is not insignificant because of what it signals, said J. Brandon Bolen, assistant professor of economics, Mississippi College.

“This increase is part of the Fed’s plan to gradually increase interest rates from the unprecedentedly low levels that we’ve seen over the last decade,” Bolen said. “The Fed is responsible for promoting maximum employment and stable prices. When the Fed is concerned about inflation, it raises interest rates to promote stable prices. When the Fed is concerned about unemployment, it lowers interest rates to promote maximum employment. So, the primary benefit of the rate increase for consumers is what it signals – unemployment is historically low. The primary cost to consumers is that borrowing money is more expensive and will continue to become more expensive if the Fed continues to increase rates.”

One downside is that businesses, like consumers, now face increased costs of borrowing money. So, business investments are now more expensive. Moreover, for those industries whose products are typically purchased with borrowed money, their products are now more expensive, Bolen said.

“However, because unemployment is falling and the economy is growing, incomes are increasing, which means businesses’ customers will spend more money,’ Bolen said. “Rates are still relatively low. Rates over the past decade were unprecedentedly low, so rates will remain relatively low even with gradual increases in the coming months.”

The Fed has indicated it may raise rates twice more this year. Bolen said, overall, rate increases are not a concern because they signal that the economy is growing stronger. Of course, whether rate increases are a concern or not is a matter of perspective.

“If you’re a borrower with, say, an adjustable rate mortgage, then the cost of owning a home will increase,” Bolen said. “In this specific case and others like it, concern may be warranted. But for the economy as a whole, rate increases are not concerning. Right now, tariffs are a bigger concern than Federal Reserve rate increases. Regardless of whether or not other countries engage the U.S. in a tariff war, tariffs are costly for American consumers. Tariffs benefit few at the expense of many. Protected industries and workers and the politicians who receive their votes benefit, while all other Americans pay higher prices, often unaware that tariffs are to blame.”

BancorpSouth Chairman and CEO Dan Rollins said the Federal Reserve’s rate hikes—two this year and seven since the end of the Great Recession— indicate that the U.S. economy continues to strengthen.

“The federal funds rate helps determine rates for mortgages, credit cards, auto loans and other borrowing,” Rollins said. “For borrowers, increases by the Federal Reserve results in higher borrowing cost. However, on the other hand, for customers with excess funds, these increases by the Federal Reserve results in higher interest income as banks raise the rates they pay on certificates of deposit, savings accounts and money market accounts.”


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