What Would Happen if the Fed Raises the Rate?

By a fairly narrow margin, a majority of economists now assume that the Fed’s Open Market Committee (FOMC) will elect to stay with the current policy of zero interest rates—perhaps until December and maybe not until sometime next year.

Within the minority that asserts a rate hike will still occur in September are those who would style themselves hawks and who have been calling for a rate hike for quite some time. Members of the FOMC have been appropriately vague regarding their intentions, but just prior to the blackout period when they elect not to comment any longer on their intentions, there was a sense of reluctance to hike at this time.

What would happen if rates were to rise this week? What is the mood of the investment community as well as the business community as a whole and the consumer for that matter?

If rates were to rise, the consensus view is the hike would be very small—no more than a quarter point. This is an extremely cautious move and realistically changes nothing as far as credit is concerned. Assuming that other rates moved accordingly, there would hardly be a reason for radical response, but there remains an outside chance the prime rate and other related rates would be pushed further than the Fed rate shift would justify. In other words, if there is a big reaction to a rate hike, it will be driven by perception and emotional reaction.

The markets should have priced in a rate hike long ago and to some extent this has happened, but the events of the last month or so has ratcheted up the tension. The expectation now is the Fed will not hike; and if they do, there will a negative response and a big market drop. Should this occur, it will not be a decline that lasts all that long as the markets have known this day was coming—although not quite when.

The dollar will strengthen immediately, and that is likely to be the most long-lasting impact. U.S. currency has been getting stronger anyway. This will just accelerate that process. The export sector has been feeling the pinch already, and this will certainly not help matters. On the other hand, a higher valued currency will make imports that much cheaper, and this will make for a better spending season.

The cost of borrowing will edge up, but few expect much given the state of the market now. It is not like demand for loans has been overpowering. The lenders will still be seeking out the good risks. A slight hike at the Fed is not going to interfere much. It was assumed that the threat of a rate hike would be enough to trigger borrowers and lenders to act before the costs grew, but thus far there has been no such surge as anybody who wanted to borrow already has. There is no sense of panic in the business community and little in the consumer sector either—both seem to have assumed that a rate hike was inevitable.

-- Chris Kuehl, NACM economist

To read more of Chris Kuehl’s commentaries, visit FCIB’s Knowledge and Resource Center.

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