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How elections, policy and other developments in Washington could affect the markets and your financial life
December 20, 2018

Another rate hike to close out the year: Is it good for the economy?

The opinions are those of the author(s) and subject to change.
As expected, the Federal Reserve raised rates a quarter point on Wednesday, citing the continuing strength of the U.S. economy. "Job gains have been strong, on average, in recent months, and the unemployment rate has remained low. Household spending has continued to grow strongly," it noted in its statement announcing the increase. This fourth hike of the year places the central bank's benchmark interest rate in a range between 2.25 and 2.5 percent.
What higher rates could mean for the economy and the markets: The major indexes fell on news of the rate hike, despite indications from Fed committee members that only two hikes might be needed in 2019 — down from three or four previously forecast. Given current investor concerns about slowing growth, "the Fed needs to pause and allow the current hikes to filter through the broader economy before they resume future rate increases," says Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust. "We continue to expect investor risk appetite to stay low until several issues are resolved," he adds. Among them: a more dovish Fed in 2019, resolution of U.S.-China trade tensions, and proof of resilience in corporate earnings.
The Fed needs to pause and allow the current hikes to filter through the broader economy before they resume future rate increases.
— Chris Hyzy, Chief Investment Officer for Merrill Lynch and U.S. Trust
"Earnings each quarter will need to maintain a trend that is positive around 5 percent growth and not fall close to zero growth," Hyzy notes. "Given the low base of 2506 on the S&P 500, relative to our fair value price of 2900, we could see the potential for 12-15 percent returns for 2019, from current levels. Volatility is not expected to subside, however, until there is full clarity on rates, trade, and earnings."
What higher rates could mean for your investments: "We remain constructive in equities for the longer-term investor," says Hyzy. "In our view, it would be useful for investors to have a disciplined plan ready to add to equities in three separate re-balancing episodes in the first half of 2019." As for fixed income, "we view shorter-term fixed income and cash yields as attractive relative to dividend yields and longer term debt."
For more insights, on what future hikes could mean for the economy and the markets, check out the latest "Investment Insights from the CIO, "A Liquidity Recession, Not an Economic One." And for a look ahead to 2019, read "Outlook 2019: Answers to 7 Key Questions."
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