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What's so bad about higher interest rates?

  • By Irwin Kellner,
  • MarketWatch
  • – 08/05/2014
  • Economic Insight
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PORT WASHINGTON, N.Y. — Sooner or later — most likely sooner — interest rates are going up, so get used to it.

Right now Wall Street is on tenterhooks, worrying that one event or another will cause the Federal Reserve to pull the trigger and raise interest rates.

For example, traders routinely parse every utterance by Fed chief Janet Yellen and her band of merry central bankers in an effort to divine when rates will rise. They are also keeping a wary eye on the Middle East, Ukraine and other hot spots around the world.

To be sure, the Fed has already made several moves that suggest higher interest rates may be just around the corner.

Earlier this year, it began reducing the amount of bonds it buys, and within a month or two, it will stop adding to its holdings altogether. It has also allowed the markets to believe that short-term interest rates will begin to rise sometime next year.

The stock market in particular doesn't like this. Since the Dow Jones Industrial Average (.DJI) breached the 17,000 mark last month, the equities market has become very nervous. Last week's plunge of over 300 points sent the Dow industrials back to its level at the beginning of this year.

A stronger-than-expected report on the second quarter's gross domestic product was greeted with boos by the Street. It's as if the stock market overlooked the fact that strong economic growth leads to strong profit growth as well.

Traders were well aware of this relationship, but focused on the likelihood that this kind of rosy scenario usually brings with it higher interest rates as well — and as we've said before, the equities crowd hates higher interest rates.

In my view, the flap over higher interest rates is much ado about nothing.

For one thing, they provide much needed income for savers. And in case you didn't notice, we are a nation of savers.

Seniors and others on fixed incomes also benefit when rates go up. These people will spend much of the incremental dollars which higher rates confer.

Rising interest rates also encourage the banks to lend. As rates go up, the spread between the cost of funds to the bank and what it gets when it lends them out will widen. But the key word here is "lend:" no loans, no spread.

Simply put, to take advantage of this money-making opportunity, the banks will have to loosen their lending standards a bit. This will help people buy houses, motor vehicles, home furnishings and other big-ticket items.

Naturally, this means better sales, earnings and dividends — all items that should warm an investor's heart.

One more thing: Unless inflation runs rampant, interest rates are likely to return only to normal levels, not much higher. Once the stock market realizes this, it may even get to like higher rates.

After all, they are a sign that things are getting better. And isn't this what investing is all about?

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Content for this page, unless otherwise indicated with a Fidelity pyramid logo, is published or selected by Fidelity Interactive Content Services LLC ("FICS"), a Fidelity company with main offices in New York, New York. All Web pages that are published by FICS will contain this legend. FICS was established to present users with objective news, information, data and guidance on personal finance topics drawn from a diverse collection of sources including affiliated and non-affiliated financial services publications and FICS-created content. Content selected and published by FICS drawn from affiliated Fidelity companies is labeled as such. FICS selected content is not intended to provide tax, legal, insurance or investment advice and should not be construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any security by any Fidelity entity or any third-party. Quotes are delayed unless otherwise noted. FICS is owned by FMR LLC and is an affiliate of Fidelity Brokerage Services LLC. Terms of use for Third-Party Content and Research.
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