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Market Wrap-up for Feb. 25 - The Fed's Rate Conundrum

It seems like each week investors find new ways to inject drama into the Federal Funds Rate issue. The speculation began when Ben Bernanke was still sitting as the Fed Chair, and has now moved its laser-like focus onto Janet Yellen, the current Fed Chair. Yellen’s words (and sometimes lack thereof) are scrutinized by the market, especially when they concern the inevitable rate hike.

The Rate Race

To say that the Fed and Yellen are in a pickle right now would be an understatement. The reality is that rates will eventually need to be raised, but the answer of when seems to change. First there was speculation that it may happen in 2014 (and some thought even earlier); now, many agree that it will happen sometime this year. Still, the 2015 predictions started off as targeting the spring, then the summer, and now it appears as though rates will hold at their near zero levels beyond June.

Keeping rates low runs the danger of inflation, as the Fed typically raises rates to curtail a jump in prices. A jump in rates would bring with it a slew of pros and cons depending on what side of the business world you’re on. But one thing has been made abundantly clear: the market is afraid of a rate hike.

Each time Yellen announces or hints that the rate hike will be delayed, stocks have rallied, allowing them to push to all-time highs this year. Likewise, even a hint of rates being raised sooner (or ambiguity as to when exactly it will happen) stops markets in their tracks and leads to profit-taking on Wall Street.

Between a Rock and a Hard Place

At this point, Yellen and the Fed are keenly aware that raising rates is very unpopular as far as the market is concerned. The last thing the Fed wants to do is trigger a correction or any kind of over-emotional reaction on Wall Street. But by that same token, the Fed cannot simply hold rates at their low levels forever; eventually something will give and rates will have to climb from their historic lows.

For the time being, it seems as though the Fed is continuing to delay the inevitable, hoping that the market will warm up to the idea of higher rates; however, the past few years have shown no signs that this will happen. No matter how many times the expected hike is pushed back, markets still spin into a frenzy whenever a suspected deadline approaches. It is safe to say that if and when a definitive date to raise rates is either set or announced, markets will sell off, period.

That may simply be pulling off the band-aid. Sure, there will be volatility in the short term and Wall Street will be buzzing for a few days, but the market’s famous short-term memory could help many get over the hump of higher rates. At the end of the day, the margin by which the Fed would raise rates would likely be so small and gradual that nobody would notice if it was not the headline on every financial publication across the country.

The Bottom Line

As an investor, there is nothing you can do but watch how the situation unfolds. Rest assured that the subject of rates will be a market driver (either up or down) for the foreseeable future. Your best bet is to ensure that your portfolio is appropriately matched with your long-term goals, and understand that short-term volatility from an over-reacting Wall Street should not shake you from your positions.

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