Interest rates have been near zero for almost seven years, so the economy hasn’t been through the tightening portion of a monetary policy cycle for a long time.
But that’s all about to change in the second half of the year, according to most analysts. The Federal Reserve has indicated it will begin hiking short-term interest rates soon, assuming the economy continues to grow stronger.
“We do think the Fed will finally move this year. They seem to be getting closer to liftoff here,” said Joel Huffman, investment managing director for The Private Client Reserve of U.S. Bank in Milwaukee. “It’s not going to be locked in stone; they’re going to see how things evolve in the economy.”
As the Fed pulls back from its economic stimulus efforts, the range of outcomes increases, Huffman said.
“More important than the timing of when they start is the path of it,” he said. “We think it will be moderate. They’ll be cautious.”
The markets can probably handle a quarter point uptick in September and another quarter basis point in December, as long as the economy continues to grow and valuations don’t get out of whack, he said. The stock market is likely to experience some volatility following the move away from longstanding Fed policy.
With an increase in interest rates, financial institutions will be able to lend out money at higher rates, which makes financial stocks a good choice for investors right now, Huffman said. He’s also recommending technology and some industrials, though the rising dollar has increased pressure on manufacturers.
“We think investors will be rewarded for sort of staying the course right now,” he said.
William Delwiche, investment strategist at Milwaukee-based Robert W. Baird & Co. Inc., took a neutral tone in his mid-year outlook report.
“If and when the Fed finally raises rates, conviction in a gradual tightening process could raise Fed policy back to bullish, and better seasonal patterns (and perhaps improved momentum) could be in store in the fourth quarter,” he said. “On the other hand, a quick return of investor optimism and/or further breadth deterioration could add downside pressure in the near term.”
Companies have been taking advantage of the last few months of very low interest rates by issuing long-term debt in large quantities. The question then is what to use the excess cash for, Huffman said.
“What some of them have been doing is using it for stock purchases if they don’t have an immediate need for it,” he said.
Patricia Lane, a partner in Foley & Lardner LLP’s Finance & Financial Institutions Practice in Milwaukee, represents large corporate borrowers in complex financing arrangements. Many of her clients are expecting a July or August rate increase from the Fed.
Those corporate borrowers are hedging transactions and converting their variable rate debt to fixed rate debt ahead of the rate hike, she said.
“The window, I think, is closing,” Lane said. “Some are borrowing at like 2 percent for five-year debt, 10-year debt. That’s extremely low.”
Lane expects that in the next six months, if the economy continues at its current trajectory, rates will rise and the window of opportunity will have closed.
The corporations she works with have been issuing public debt to take advantage of low interest rates, but some are uncertain about expanding, making an acquisition or buying equipment, so they tend to sit on the sidelines and keep that cash on the balance sheet.
“Corporations don’t like uncertainty and they don’t like when the effect of regulations are unclear and that leads them to nurse cash,” Lane said. “I haven’t seen too much pulling the trigger, but a lot of exploration.
“A lot of companies now have the cash, they have the war chest built up. So I think there will be a lot of activity when the market perceives there’s value.”
