History points to higher rates

by Puru Saxena

The New Year has started with a loud bang with global equity markets charging ahead. Investors worldwide seem to be celebrating the Fed's announcement, which stated that its policy outlook "was becoming considerably less certain", the number of additional rate hikes to control inflation "probably would not be large" and the future rate decisions "would depend on the incoming data".

The above statement was perceived as a rather soft message and investors now believe that the interest-rate hikes are about to end. On this expectation, the markets reacted sharply and equities as well as bonds rallied, the US dollar sunk and precious metals rebounded after the recent sell-off.

In my opinion, the markets over-reacted to this news as I feel that the Fed funds rate is going to rise significantly in the future. Perhaps, the Fed will pause momentarily after the Fed funds rate is pulled up somewhat more but the overall trend for interest-rates is now up. Take a look at the chart presented here, which shows the direction of the Fed funds rate since 1955. The Fed funds rate went up from 1955 to 1981. Thereafter, the cost of money (interest-rate) declined for the next 23 years. I believe this cycle reversed when the Fed funds rate bottomed at 1% and we are now in the early stages of a major uptrend, which will probably last for years.

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