Higher Interest Rates May Actually Be Good For The Markets And Economy

 |  Includes: SPY
by: Robert Wagner

I recently wrote an article titled "Higher Interest Rates Don't Necesssarity Mean Lower Equity Prices." In it I outlined a theory where "this time is different" because unlike most times in the past, rising interest rates this time would be a return to "normalcy" signifying that confidence is returning to the markets, and that would be a good thing for the equity markets. I also wrote an article titled "$2.6 trillion in Money Markets May Slow Rate Increase," that outlined the theory that the sizable holdings in money markets would likely provide a buffer against rising interest rates. Both of those concepts were discussed in this recent CNBC video.

The video also added some concepts not covered in my other two articles and presented a theory that rising interest rates can actually be stimulative by encouraging people to buy housing before rates go higher. This is much like the impact inflation can have on an economy where people rush out and buy before prices go higher. The video also highlights how higher interest rates are also positive for banks.

This video highligts how higher equities with a backdrop of rising rates is a positive for the markets. The markets are climbing a wall of worry. That worry is based on a historical relationship of interest rates and equity prices that may not justify the worry this time.

This video expands upon the theories discussed above, and adds how when the markets decide that the Fed policy has changed there will be a "student body right" move out of the bond market. Basically the bond market is like a game of musical chairs, and everyone is waiting on the music to stop before making a move. The key issue raised in the video is "how high interest rates have to go to be counter productive." That is the ultimate and unanswered question that needs to be answered, and only time can do that, so for now, the music plays on.

In conclusion, rising interest rates are not likely to have the contractionary impact on the economy and markets as they have in the past. In fact, the initial boost in interest rates may actually have a counterintuitive stimulative effect by causing people to get off the fence and go make the big purchase that they have been postponing. Eventually rates will hit an inflection point where higher rates do have a detrimental impact on the economy and markets, but that level is likely far away. Plenty of cash on the sidelines and excess capacity in industry and labor also provides a buffer against much higher rates, as does a slowing China. So for now, the music plays on and bond holders appear content with their holdings. The big fear however is what happens when the music does stop and the bond investors do a "student body right" move for the exits. When that happens, I would imagine the old relationship of interest rates and equity prices will be restored, but in my opinion, that is awhile away.

Disclaimer: This article is not an investment recommendation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.