Dow Climbs After Fed Projects Higher Interest Rates

The Federal Reserve ended a two-day policy meeting this afternoon and showed a hint of optimism about the economy. After a slight contraction in the first quarter, the Fed now expects GDP growth of 2.2% in 2014, indicating a pickup during the second half of the year.

The Fed's short-term interest rate, called the federal funds rate, is projected to rise to 1.2% by the end of 2015 and 2.5% by the end of 2016, which wouldn't be the case if more growth weren't expected. When combined with another taper, bringing monthly bond purchases down to $10 billion, the easy money the Fed has provided for the economy is also slowly being shut off.  

Interestingly, the Dow Jones Industrial Average (DJINDICES: ^DJI  ) actually rose after the announcement, which isn't always the case when interest rates are projected to go up. But the Fed's policy has both good news and bad news for stock investors.

Investors took a bullish view of the Fed's policy today.

What this means for stock investors
The end of ultra-low interest rates will eventually mean that it'll be harder for companies to borrow money -- or they'll have to do so at less attractive rates. In theory, that could leave less money for investment or expansion by companies who borrow money.

But we've seen companies pull back on investment and actually hoard cash since the recession, so low interest rates are doing little to push more investment. But a higher growth rate in the U.S. could change that.

One of the reasons companies are hesitant to invest in new products and equipment is that the economy is so sluggish. Hanging on to cash is looked at as a safer use of money than risking it on new investments that may not carry high returns given the state of the economy. So, more growth or a lower level of unemployment -- the Fed predicted a rate slightly above 5% in 2016 -- could give companies a reason to invest.

That optimism is why the Dow Jones Industrial Average didn't sell off after the Fed's announcement today. It'll take time to see whether the Fed's predictions are correct, but for now a higher growth forecast is a small reason for hope.

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  • Report this Comment On June 18, 2014, at 4:47 PM, AdamGalas wrote:

    Projecting rising rates through 2016? Seems like an academic exercise only. We're in year 6 of a bull market and recent market rises haven't been based on fundementals but momentum.

    We're overdue for a recession in the next year or two and unless inflation really starts increasing I don't think the fed will have the guts to raise rates, not with economic growth at 2.2%, with interest rates at 0.25%.

    Look at the recent jobs numbers, under 200,000. We need 150,000/month to keep up with population growth. 200,000 is just barely a recovery and there are still a lot of people waiting for the economy to recover for them.

    I could see the fed raise rates just to give them a weapon against the next recession, but I fear the economic recovery won't ever really kick off.

    We've been hearing about the supposed acceleration of the recovery for several years, but it just isn't happening and likely won't. I may be wrong, but I think rates near 0 are the new normal.

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