Blog

 

How Interest Rate Changes Can Predict the End of the Economic Cycle

8/27/2021

For stock investors, remaining aware of directional changes in the economic cycle is key to making good portfolio decisions.

If economic growth remains strong and prices stay elevated amidst shortages of labor and supplies, the Federal Reserve may need to reign in its ultra-accommodative monetary policy. While Fed Chairman Jerome Powell said in late July that the Fed was “a ways away from considering raising interest rates” and terms rate hikes as “something that is not on our radar screen now,” some Fed governors are starting to hedge their bets. Several have publicly observed that Fed criteria for raising rates is starting to be met.

As a prelude to raising rates, the Fed would most likely reduce its $120 billion of monthly bond purchases on a gradual basis, known as “tapering.” Fed officials seem to be floating trial balloons of this nature to gauge market sentiment and avoid repeating the ”taper tantrum” when markets went into convulsions as the Fed reduced bond-buying in 2013.

Rising interest rates are an eventuality and a sign of good health that the economy can finally stand on its own again. However, bond markets will not be happy with the tapering of bond purchases and higher interest rates. The stock market typically doesn’t react well to repeated interest rate hikes either, but starting from zero gives quite a bit of room before higher rates are likely to harm the economy in the short run.

Eventually, however, the Fed will take away the punch bowl and the party will come to a temporary end. That is how most economic expansions exhaust themselves and new ones begin. Historically, the stock market has anticipated the end of an economic cycle 6-9 months in advance. Given that interest rates have declined in recent months, we should not be anticipating an end to this economic cycle anytime soon.

When the cycle does shift, you can count on the Investor Advisory Service to let you know the impact on the stocks covered in the newsletter so that you can make the best decisions about your portfolio.


Reprinted from the September 2021 issue of the Investor Advisory Service. For more information, to download a sample issue, or to subscribe to the best investing newsletter in the U.S., visit Investor Advisory Service.