What History Says About Fed Rate Hikes

Yesterday, Janet Yellen gave her first post-FOMC meeting press conference.  In her prepared statement, she stated exactly what was already expected: 

1) accommodative policy will remain in place for a considerable amount of time after the current quantitative easing program ends this fall,

2) employment is improving,

3) the economy is recovering but has more work to do, and;

4) the current quantitative easing program would be “tapered” from $65 to $55 billion per month beginning in April.

The problem for the markets came during her press conference when she was asked what a“considerable amount of time” between the end of the current QE program and the first rate hike would be.  She replied: “About six months.”  It took the markets about 5-seconds to understand exactly what that meant: “Rate hike in early 2015.”  If you want to know the precise moment that those words were uttered, just look at the chart below to see if you can figure it out.

The question is this: 

“If the Fed begins to hike interest rates, what effect does that have on the economy and the markets?”

According to Jim Cramer last night, he said the idea of rising interest rates shocked the markets, however, in the long-term it’s a positive sign. Rates rise as the economy does better. 

 

 

The assumption he makes is that as the economy “catches fire” and corporate profits increase, then it is natural for interest rates to rise also.  If a growing economy is a function of expanding profitability, then what is wrong with the chart below. (For more detail read: 50% Profit Growth)

“The chart below shows corporate profits, per the BEA, divided by GDP.  (You can substitute GNP but the result is virtually identical between the two measures.)”

“The current levels of profits, as a share of GDP, are at record levels.  This is interesting because corporate profits should be a reflection of the underlying economic strength.  However, in recent years, due to financial engineering, wage and employment suppression and increase in productivity, corporate profits have become extremely deviated.”