Rising Rates, Rising Expectations?

The Federal Reserve went ahead with a widely expected decision to boost short-term interest rates Wednesday. And as is so often the case, the action begs the question as to what lies next, as in right around the corner.

At this writing, just as the announcement was being released, stocks were higher, but not by much. It may be no surprise that banks stocks were widely higher, given the fact that higher interest rates presage growing returns on lending activity, which should boost margins and even dividend payouts. Some of the biggest names in the sector, such as Bank of America and JPMorgan, were higher on the day. Those names, and others, helped drive the Dow up 50 basis points on the session.

The rate hike comes off an unusually low base, and keep in mind that by historical standards we have been at decades-long lows and now stands in a range of 75 basis points to a full percentage point. That’s not all that much of an interest rate no matter how you slice it, pretty much. But credit interest rates will be reset higher rather quickly. That spells higher payments from consumers, of course. Broken down annually, even a quarter percentage point rise, divvied up over 12 months, may not be all that tough for consumers to swallow. But home loan rates and auto loans will also price higher.

The real question is where the tipping point lies, in other words where rates will shift higher to the point where consumer lending is rendered unpalatable for consumers. The central bank is on the verge of lifting rates at least a few more times this year, so the conventional wisdom holds, and borrowing will become more expensive. The economic data is there for the continued tightening as unemployment sits at about 4.7 percent, and job growth has been higher than estimates over the past few weeks.

Bond yields have increased (with bonds falling), and there are implications here for the stock markets as well. The Dow sits below record highs, but not by much. Investors may eye yields as an (eventually) attractive consideration against what might be perceived as an increasingly frothy market. Maybe, but given the bank stock rally and the continued sway upward of the markets, not quite yet.