The U.S. economy continues to be full steam ahead like a raging locomotive backed by a strong stock market that has already seen major indexes like the S&P 500 reach record levels. As such, the Federal Reserve is primed to continue its hiking of the federal funds rate, which has already gone up twice this year.
“Gradually increasing over the course of this next year makes sense,” said Eric Rosengren, Federal Reserve Bank of Boston President in an interview with CNBC. “If things work out well for the economy, and that’s what I expect and hope, then we’ll be in a situation where we need to have somewhat restrictive policy over time.”
The Fed’s monetary policy meeting is slated for later this month, and Rosengren forecasts that the current federal funds rate will float between a range of 2.5% to 3%. Backed by a revised GDP growth in the second quarter of 4.2%, the economy has grown at a pace not seen since the third quarter of 2014–a sign of more rate hikes to come, which can continue to materialize in the form of certain benefits.
Inflation Control
Just last week, the U.S. Commerce Department reported that the consumer price index (CPI) rose during the month of August albeit at a slower pace than the previous month, reflecting the first slowdown in the past year. The Fed’s target inflation rate is 2, which they have yet to do on a sustained level.
Source: tradingeconomics.com
Nonetheless, market experts feel that the Fed can keep inflation under control as an economic environment of rising rates continues.
“In many ways, the current inflation environment is just what the Fed wants to see,” the Wells Fargo Research Team noted. “Core inflation has slowly moved back up to levels consistent with the FOMC’s target. Yet there are few signs of inflation blowing far past the Fed’s comfort zone and forcing the Fed to raise rates faster than expected; inflation expectations—especially longer-term views—have been little changed.”
Stronger Dollar
Rising interest rates reflect on a stronger dollar, which encourages foreign investments from aboard, furthering the U.S. economy. The U.S. Dollar Index has began to see a rise as of mid-April, which could continue if rates continue their upward trajectory.
Source: tradingeconomics.com
However, counteracting this stronger dollar is a decline in safe-haven assets like gold and further strength in the greenback could go unobstructed, particularly while the trade spats between the U.S. and China continue.
“The main issue is that this concern over trade tensions between the U.S. and China is translating into a stronger dollar, and that is weighing on gold,” said Jonathan Butler, commodities analyst at Mitsubishi in London. “I think we’ll continue to see gold under pressure. As long as the dollar remains relatively well supported, yields continue to rise and the U.S. economic growth story remains in place, it’s hard to see where a strong rally would come from in gold.”
Higher Returns on CDs
With current investor sentiment in a risk-on mode, capital allocations to certificates of deposit (CDs) have fallen to the wayside, but CD rates have been on the move, climbing to as high as 3% at certain online banks versus their brick and mortar counterparts. With the floodgates opening to positive news regarding the economy, it sets the stage for the Fed to announce more interest rate hikes in September in addition to the pair of rate hikes already seen this year.
CDs have been beneficiaries of these rate hikes with banking institutions like Citizens Access and PurePoint Financial offering 3% rates on three-year terms. Unlike the traditional brick-and-mortar banks, online banks do not have the operational costs associated with branches like Bank of America or Wells Fargo.
Traditional banks build their business models around customer retention and convenience rather than trying to attract new prospects based on higher interest rates. Online banks, however, can bypass the operating costs necessary for traditional banks and offer higher rates on their products like CDs.
Related: ‘A Lot Has to Change’ to Reach 5% Treasury Yield
For more trends in fixed income, visit the Rising Rates Channel.