Is the Economy Ready for Higher Interest Rates?

Image for the U.S. economy

It happens all the time.

My wife and I get into a heated debate, either on politics or other social issues, and before it’s over, we’ve forgotten what started the debate.

It may start with who should be the next president, but it ends up being a debate on who does what around the house.

We lost sight of what our true focus was.

I would say the same thing is happening at the Federal Reserve.

Members this past week were making their arguments over a September rate hike, but they are missing the point of what is actually behind a rate hike — our economy.

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“I think the point of liftoff is close,” was Atlanta Fed President Dennis Lockhart’s comment on rate hikes, all but assuring the market that September was D-day for the first interest-rate hike since 2006.

Then, Fed Vice Chairman Stanley Fischer commented that a September hike is not a done deal, pushing expectations back to October or December.

But, if you pay too much attention to this debate cycle, you end up missing what the bigger debate is about — is our economy even healthy enough for a rate hike?

The answer is no.

And the Fed knows it…

This not only tells us that low rates are here to stay, but it also tells us where to invest: utilities, real estate investment trusts (REITs) and master-limited partnerships (MLPs). Let me explain.

The Economy Isn’t Ready

For a rate hike to occur, there is one thing that must accompany it, and it’s the only debate we should be having today — a stronger U.S. economy.

Low interest rates act as a boost to the economy; they spur lending and encourage spending capital. Higher interest rates do the opposite; they suppress lending, and encourage saving — both of which slow an economy.

In other words, if rates were to lift off in a fragile economy, one like we have, it could cause a greater collapse than the financial crisis because the few people who are spending now would stop and sock their wealth away in savings to enjoy the higher rates.

If the Fed were to raise rates by a minimal tenth of a basis point, it wouldn’t mean anything. And if the Fed pushes for a typical quarter-of-a-point hike, that would likely be the last rate hike for another decade.

To know why this will be the case, look no further than the latest economic data.

  • Payrolls grew by 215,000 jobs last month, a touch below Wall Street expectations of 225,000 — and the majority of those jobs came at the lower end of the pay spectrum.
  • The Institute for Supply Management’s manufacturing data, released last Monday, were below estimates: U.S. manufacturing fell to 52.7% in July from 53.5% in June.
  • New home sales were weak, falling 6.8% in June to 482,000, the lowest since November 2014.
  • Consumer sentiment came in at 93.1, below the 94 estimate.
  • And GDP for the second quarter was at 2.3%, well below the 2.9% consensus.

Existing home sales were the only noteworthy numbers that came in slightly ahead of estimates.

At best, this equates to a mixed bag of data. But, if anything, this data is screaming that our economy is weaker than portrayed.

The Hunt for Yield

Based on this economic data, the signal is clear. The Fed can’t raise rates by any meaningful amount and global yields are going to remain dismal for years to come. The hunt for yield continues.

Over the past week of trading we’ve seen how traders will react once they come to the realization that low rates are here to stay — utilities, REITs and MLPs rose while broader markets tanked.

These market segments offer high yield, which also provides investors safety during a downturn in the market. If stocks are going to slide, it’s better to at least collect a nice dividend along the way. But demand for these high-yield stocks also supports their price, which is why these segments rose earlier this week. And it’s why you should invest in them today.

So it doesn’t matter if we get a minimal rate hike in September, October, December or even sometime next year. The Fed’s hands are tied — our economy is simply not strong enough to sustain a normalized rate environment, and that is what matters.

Once the various markets realize the Fed’s debates on when rates are going to rise is irrelevant, these are the stocks you will want exposure to.

Regards,
Chad Shoop Sovereign Investor
Chad Shoop
Editor, Pure Income