Why the Fed could surprise, and raise rates this year

The Federal Reserve is “patient,” for now. It’s not planning to raise interest rates, following its latest policymaking meeting, which is bullish for stocks and might help keep President Trump’s blood pressure down.

But markets should be prepared for rate hikes later this year, one prominent investor thinks. “By the time we get to the third quarter, the Fed is going to be looking at an economy that is much stronger than they think it is now,” Scott Minerd of Guggenheim Partners told Yahoo Finance at the recent Milken Institute Global Conference in Los Angeles. “So ultimately, they will have to begin raising rates again to keep inflation contained.”

Changes in Fed policy have roiled, then calmed, markets during the last 12 months. The Fed began raising short-term rates at the end of 2015, in measured quarter-point increments. By December 2018, rates had gone from almost 0 to nearly 2.5%, which is still low by historical comparisons.

But wobbles in the economy led investors to think the Fed was being overaggressive by the end of 2018, prompting a sharp stock selloff to end the year. So earlier this year, Federal Reserve Chair Jerome Powell said the Fed would pause its rate hikes. Many think the Fed is now more likely to cut rates than raise them, to deal with slowing growth. The Fed itself foresees GDP growth of 2.1% in 2019 and just 1.9% in 2020.

Markets sometimes fall on rising rates, since credit becomes more expensive. But Minerd, global chief investment officer at Guggenheim, thinks stocks will rise if the Fed raises rates as he foresees, because it would be a response to stronger than expected growth. “History shows us that rising rates as a result of economic growth translates into higher earnings expectations,” he says in the video above. “So I think the first move throughout the summer will be positive for equities.”

President Trump might still be displeased. He has lambasted the Fed for raising rates, even though the policy began while President Obama still had 13 months in office. Trump wants the Fed to cut rates, to stimulate the economy as he campaigns for reelection in 2020.

The Fed may yet end up doing that. Minerd thinks the stock market is in the late stages of a 10-year really that has seen the S&P 500 rise more than 250% since it bottomed out in March 2009. “I think we probably have another, let's say, 10, 15, 20% to run,” Minerd says. “Given all the uncertainties in the world, for another 20%, it really doesn't seem to be a prudent investment.”

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Rick Newman is the author of four books, including “Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman