For the first time since 2015—and just the second time in a decade—the Fed has raised the Fed funds rate. The move comes as a surprise to virtually no one; the Fed telegraphed its intentions and the markets had priced a 0.25% interest rate hike into the market. We think investors have three reasons to celebrate.
Rising rates is a good sign that the Fed has confidence in the economy’s growth and resilience. The Fed wouldn’t raise rates if they believed the economy’s growth was not sustainable. And the economic data bear that out:
- GDP grew at a modest but healthy 2.9% rate in the third quarter, doubling the second quarter’s lackluster 1.4% rate.
- November’s unemployment rate fell to 4.6%, a rate many economists consider full employment. The last time unemployment was this low was in August 2007, nearly a decade ago.
- Manufacturing activity is trending up as well. The November ISM Manufacturing data was better than expected at 52.3, and a recent Business Insider report showed regional data was looking strong as well.
These positive economic signs point to diminished slack in the economy and labor market—both a firmer rate of growth and a strong decline in unemployment.
Rising interest rates are good for bonds.
Believe it or not, a rising interest rate environment is really good for bonds. Even though investors will see negative prices in the short-term, rising rates means that our savers—those who invest more in bonds—likely will start seeing higher interest income from higher rates over the longer term. And that is good news for bond investors who have been stymied by low yields.
Rising interest rates mean investors should consider active management in bonds.
We believe we’re beginning to see the Fed’s long, slow turn toward higher, more historically typical rates. So investors would be wise to rely on more nimble active management in bonds so they can adjust to changing conditions. The bond market is huge and complex, and like an aircraft carrier, it needs a lot of time to make big turns. So, while we think it’s unlikely that the Fed will raise rates astronomically over the short term, investors should steer clear of passive investing and be prepared to make thoughtful course corrections to their bond allocation.
We believe any future interest rate moves will be dependent on data regarding economic growth, the labor market, and inflation. As Janet Yellen indicated, the Fed’s “monetary policy is not on a pre-set course.”
Given the downward price pressure and ongoing uncertainty, the bond market could continue to be volatile. We recommend holding on tight to avoid making emotional investing mistakes.