Jun 16, 2016 4 min read

Once again, the Federal Reserve Board kept interest rates the same this week, stating it was uncertain when it may raise them. Interest rates have been near zero for eight years. The Fed has kept them low to try to stimulate the economy since the Great Recession occurred in 2008.

The idea is more people will be able to afford to borrow, which will lead to more autos, major appliances and houses being purchased. This creates jobs as manufacturers need to hire people to produce these goods. They will also have to buy parts from their suppliers and all of this expands the economy.

Businesses have benefited from low interest rates and purchased new equipment or expanded their manufacturing plants. All of these activities have a multiplier effect throughout the economy. The Fed supplemented these activities with the practice of quantitative easing, purchasing massive amounts of federal debt to create yet another pressure point on interest rates.

The United States sells treasury notes and bonds at auctions where the party willing to accept the lowest interest rate gets to buy this government debt. This helped to hold down other interest rates because it created more demand than supply. The Fed stopped buying the QE programs, and at some point will have to decide what to do with the billions of dollars’ worth of debt it owns.

Central banks around the world took similar actions. In Japan and some European countries, interest rates have gone negative. This means borrowers are actually paying banks to take their money. Sticking it under a mattress never sounded better.

Last December, the Fed finally raised interest rates a quarter of a point. The stock market went down 10 percent. Why? The stock market has been a huge benefactor of low interest rates for three reasons.

First, investors were forced to take on more risk since certificates of depost are paying such a low rate of interest, they are not even keeping up with inflation. Investors know there is much greater risk in the markets, but they have little choice if they want an opportunity for growth. The stock market is the largest auction in the world. With all of this extra money pouring in, prices had to go up.

The second reason for the market’s upswing is many companies borrowed low-cost money to buy back shares of their own corporations. This automatically increases earnings per share since there are fewer shares outstanding. Often earnings per share are used to determine the value of a stock’s price. Finally, these actions lowered companies’ borrowing costs, thus increasing profits.

In December, when the Fed did raise interest a quarter of 1 percent, it indicated it would probably raise rates four times this year to start working back to normalized rates. It got spooked when the stock market reacted so negatively. So far this year, it has not taken any action, and Wednesday’s decision extended the inaction on a rate increase.

Some economists believe a July rate increase could be possible if the job market rebounds and markets stay calm following Britain’s vote next week on whether to leave the European Union.

What would another interest rate increase mean for all of us? The cost of borrowing will probably move up a little. The dollar will strengthen against foreign currencies so our exports will cost more overseas and imports will cost less. Oil is priced in dollars so the price may experience downward pressure. Do not expect to see much of an increase in bank deposit rates because banks already have more deposits than loan demand, so there will not be much upside.

How the stock market may react to the next hike is unknown. It had a bad reaction in December, but an interest rate hike should be no surprise to investors. As rates normalize over the next year or two, there will be more options to market risk, so that should be focused in investment planning.

But we’ll have to wait awhile longer to see if December’s rate increase becomes a trend.

Gary Boatman is a Monessen-based certified financial planner. He is the author of “Your Financial Compass: Safe passage through the turbulent waters of taxes, income planning and market volatility.”

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