No Recession if Rates Rise

A Bank Vault

A Bank Vault

Research by Oxford Economics shows that the US economy would not fall back into recession if the Fed decides to raise interest rates. Great news! However, there would be many negative consequences for growth and financial markets should they decide to raise interest rates more quickly than previously predicted.

The markets are uncertain, and the Fed has discussed raising rates sooner than their initial forecast of holding off until June 2015 before raising the federal funds rate, so Oxford Economics, and Kathy Bostjancic wanted to research what would happen if those markets dictated an steeper increase.

The Federal Open Market Committee (FOMC) has the difficult task of having to find the best time to raise rates and then communicate that to the investors. Financial markets in the past have proven to be susceptible to sudden tightening of economic policy. This happened in 1994.

The conclusion is that if the Fed does rates, as it said it might do sooner than previously anticipated, there would be consequences to stock and bond markets but it would not trigger a bear market.

The reason the Fed is considering tightening it’s policy is wage pressures which could lead to inflation. The Fed is worried about inflation, but they have stated their number one goal is full employment. There are signs that these wage pressures are already building. The unemployment rate gap measures show little slack in the short-term unemployed.

The possible impact higher rates could have on the economy include less growth, less business investment, slower housing market activity, and a stagnant unemployment rate. This stagnant unemployment rate is contrary to the Fed’s goal of full employment.

There would, of course, be a positive effect as well, in the form of foreign investors interested in safe investments in a stronger dollar. This, according to Oxford Economics, would not offset the negative impact of increasing rates.

One thing is for sure, it’s important the Fed’s communicates and manages market expectations. Whether investors will listen remains to be seen.