During the first quarter, investors remained focused on the Fed and the prospects of higher interest rates sometime later this year. As a result, market volatility remained elevated compared to the relatively docile first half of last year. Despite significant day-to-day fluctuations, returns for the major indexes were muted but generally positive through the first three months of the year. The S&P 500 gained one percent. Bonds also bounced around but finished the quarter slightly higher. The 10-year Treasury yield began the year at 2.12% and declined slightly to 1.94% to close out March.

For nearly two years, markets have been grappling with the Federal Reserve’s “exit strategy” and timeline. On May 22, 2013, then Fed chairman Ben Bernanke announced the Fed’s plans to begin tapering its asset purchases perhaps as soon as later that year. Stocks corrected sharply in a mini-panic that was dubbed the “taper tantrum.” We called the negative reaction unwarranted and welcomed the beginning of the end of Fed involvement in financial markets. One year later, the S&P 500 was 14% higher than pre taper tantrum levels. Today it is up 25% since Bernanke’s shot across the bow.

Then, Peloton argued that the eventual removal of Fed accommodation would not undermine the ongoing economic expansion simply because we never believed that artificially low rates were actually helping drive growth much. Throughout the recovery, banks – weighed down by new and onerous regulation – remained reluctant to lend, so although capital was cheap, it was generally unavailable or not needed. Borrowers with exemplary credit were able to improve terms on existing borrowings, but little new borrowing was spurred by low rates because the mechanism by which low rates impact the real economy (lending and borrowing) was broken. Furthermore, untoward fiscal policy and uncertainty regarding overreaching legislation like the Affordable Care Act encouraged businesses to curtail growth plans and instead hoard cash. So, if we’re correct, when the Fed actually starts tightening, the economy will not falter.

Similarly, financial markets are unlikely to be roiled by the first rate hike. Markets are only rocked by surprises, and when the Fed acts, it will hardly be a surprise after two years of handwringing. In 2013, no one expected Bernanke to mention tapering the pace of QE monthly purchases, and the short-lived temper tantrum ensued. The pullback was quickly reversed as investors began to consider why the Fed might remove its proverbial punchbowl. It would only do so if it deemed the economy strong enough to withstand the gradual removal of extraordinary “stimulus” that it provided during and post-financial crisis. Two years later, the Fed has tapered the exceptional measures, and the economic data continue to suggest that the expansion remains on solid footing. If and when the Fed takes the actual step of tightening policy by raising rates, we believe it will be because either its forecasts are more optimistic or because its confidence in a more modest but solid growth path is bolstered. If that seems unlikely, consider three strong economic tailwinds: 1.) Energy prices have collapsed within the last year, which benefits consumers and virtually all non-energy producing companies. 2.) After seven years of underinvestment by homebuilders, the inventory of houses for sale is exceedingly low and needs to be replenished with new construction. 3.) Wage growth is evident in pockets of the economy for the first time since the recovery began.

Right now, the U.S. is the global economic bright spot, and as a result, the U.S. dollar has strengthened relentlessly compared to other major currencies. This free-market force, in and of itself, acts as a de facto tightening mechanism and has likely given Fed chairman Yellen even more breathing room before hiking rates. And yet despite this strong-dollar-induced tightening, GDP growth and profits remain solid. Peloton forecasts that whenever the Fed increases the Fed Funds target interest rate, markets will vacillate, but the trend will remain consistent with a growing economy and all-time high corporate profitability.