Economy's pace may bring rate hike
By Rachel Beck
Associated Press
NEW YORK — Well, we wanted the economy to heat up, and it sure seems to have done that, practically burning in the third quarter. Now we may have to pay the price.
The recent flurry of positive economic news is raising the possibility that Chairman Alan Greenspan and his Federal Reserve colleagues will soon lift interest rates from their 45-year lows. Its intention will be to put the brakes on potential inflationary threats before they even happen.
But higher rates aren't without consequence. They could curb the stock market's future gains and raise costs for anyone who needs to borrow money.
"Be careful what you wish for" was the headline Wachovia Securities chief investment strategist Rod Smyth used last week in his note to clients. His point: While so much focus has gone to getting the economy going again, the worry now shifts to whether interest rates will have to go up to keep the party under control.
Right now, the benchmark federal funds rate on overnight loans stands at 1 percent after being knocked down 13 times since 2001 in the Fed's attempt to jump-start the economy.
The declining interest rates have fueled a surge in mortgage refinancings, which put cash in consumers' pockets, and has decreased the cost of many other types of loans.
Finally the overall economy is staging an impressive run, growing at a scorching 7.2 percent annual rate in the third quarter, thanks to solid gains in business spending and productivity.
In addition, the labor market has made a significant turn over the last few months. Employment grew by 126,000 jobs in October, and job growth was stronger than the government had initially estimated in August and September.
While the Fed's policy-makers have said their current low-rate policy could be "maintained for a considerable period," they may be forced to reconsider that view given the spate of surprisingly strong data in recent weeks.
Already economists are revising their forecasts to reflect short-term interest rates going up by the middle of next year — largely a result of the economy's pace, but also having to do with their predictions that the Fed will likely avoid any rate moves too close to next November's presidential election.
According to the rate expectations tracked on the Chicago Board of Trade, investors believe there is a 100 percent chance that the Fed will boost rates to at least 1.5 percent by its June meeting and about a 50 percent chance that they could go as high as 1.75 percent.
"The Fed will want to see the fourth-quarter numbers to make sure that business spending continues and that the job recovery isn't a head fake," said Richard J. Nash, chief market strategist at Victory Capital Management. "But if there is stronger growth and improvements in the job market, they will have to bump up rates."
From a business perspective, higher interest rates translate into higher borrowing costs, which can directly reduce company profits. For consumers, this could lower spending on items normally purchased with borrowed money, like houses, appliances and cars.
Though rising rates will be welcomed by savers, they could also rattle the stock market. As rates go up, so do yields on Treasury bonds, and that means that stocks need to deliver higher returns to keep up.
That's not to say the Fed will aggressively bump up rates. Economists expect the process to be slow, and point out that rates are coming off a very low base — at 1 percent, the rate is far below its peak of 6.5 percent 3 1/2 years ago.
Still, higher rates will mark a distinctive shift in Fed rate policy for the first time since January 2001. So while we have a healthy economy again, higher rates now have to be factored into the mix.
It's always something. Not even good times come free of charge.
