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Rates Will Rise as Labor Market 'Slack' Outweighed by Stability

After previous recessions, the labor market has been quick to rebound higher. Since 2010, however, our economy has improved at a more gradual pace. Nonetheless, improvement warrants an increase in short-term rates from its current rock-bottom levels.

The chart below represents the effective federal funds rate controlled by the Fed. Changes in the Fed funds rate closely mirrors changes in the labor market indicator above.

Just before the financial crisis a few years ago, the labor market and Fed funds rate were both on an upswing together. In the post-crisis environment, however, the rate has been slashed to historic lows, allowing time for employment to recover.

Although the employment situation is in no way "spectacular," it is as good as it has been in the last five years. This alone should give the Fed confidence to begin gradually raising rates as labor conditions continue to stabilize.

If rates do hike in 2015, it will present great opportunities to get both short and long various assets. On the short side Utilities Select Sector SPDR (XLU), iShares Barclays 20+ Year Treas Bond (TLT), SPDR Barclays High Yield Bond (JNK), and iShares Dow Jones Select Dividend Index (DVY), which are all interest rate sensitive, should fall as rates improve.

Meanwhile, PowerShares DB US Dollar Index Bullish (UUP) and iShares Dow Jones US Regional Banks (IAT), which benefit from higher interest rates, should catch a bid higher.

Economic activity is not robust by historic standards, but it is strong enough to expect policy tightening and prepare your portfolio for the aftershocks.

At the time of publication, the author had no position in any of the funds mentioned.

Follow @macroinsights

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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