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Fed-phobiacs: Relax, everything's going to be OK

Relax, Fed watchers. Take a deep breath. Everything is going to be just fine.

After months of anguished speculation, global investors, small businesses, politicians and economic wonks are bracing for impact as the U.S. Federal Reserve appears determined this week to raise a key short-term interest rate target for the first time since it flattened borrowing costs after the global financial system melted down in 2008.

The widespread angst and predictions of dire consequences continues to rattle the financial markets. The relevant data, however, indicates that the Fed's widely anticipated move will likely have about as much market and economic impact as the much-feared Y2K computer panic that ushered in the millennium.

But for all the doomsday scenarios rattling the financial markets, the impact of a one-quarter percent increase in the so-called fed funds rate — the interest rate banks charge each other for overnight loans — will likely cause barely a ripple in the U.S. economy.

To be sure, the economy — both in the U.S. and abroad — faces a series of headwinds from weakening growth in China to the collapse in oil prices that is hammering American oil and gas producers in energy-rich parts of the country.

Read More Oil and gas job cuts: The US regions most at risk

But overall, the U.S. economy has returned to a steady — if slower than normal — pace of growth. Unlike some past tightening cycles — when rate hikes were designed to combat rampant inflation of the 1970s or curb the "irrational exuberance" of the late 1990s — this round of hikes follows improving conditions.

"Policymakers in the U.S. will raise interest rates because the economy is strengthening — rather than for some other more ominous reason," said Neil Shearing, and economist with Capital Economics, in a recent note to client. "Accordingly, the economic backdrop is a favorable one."

After seven years of its extraordinary effort to suppress short-term interest rates to abnormally low levels, Fed policymakers now believe most economic data show that it's time to get back to a more "normal" level of interest rates.

In 2008, when the Fed pulled out all of its monetary stops following the 2008 collapse, the move was designed to stabilize the global financial system get the U.S. economy back to a more "normal" footing. To gauge what is "normal" for the Fed, there are two basic measures — the central bank's so-called "dual mandate" — solid job growth and stable prices.

The recovery of the job market since the Great Recession offers the clearest sign that it's time to boost short-term rates from abnormally low levels. All six measures of unemployment — including the "headline" rate of 5.0 percent — have fallen to levels at or close to pre-recession levels. The pace of layoffs has fallen, and job openings are well above levels seen before the Fed began flooding the economy and financial system with cheap money to boost hiring.

The case for raising rates based on the Fed's second main mandate — keeping inflation in check — has been harder to make. A weakening global economy, especially in China and other parts of the developing world, have sent oil and other commodity prices tumbling. That's sparked fears of deflation, a dangerous slide in prices that can be hard to reverse.

But while U.S. inflation remains below the Fed's 2 percent annual growth target, it's hardly gone away.

And, given the downward pressure from commodity prices, Fed policymakers are looking closely at various ways to measure the long-term trends in price changes. One measure tracked by the Dallas Fed tries to smooth out some of the price volatility using a "trimmed" index that eliminates extreme data points on the high and low end. By that measure, inflation is running at an annual rate of about 1.7 percent.

While that's still below the Fed's target — it's not far off the mark as to justify keeping short-term interest rates at zero, according to St. Louis Fed president James Bullard.

"An important drawback to the strict inflation targeting view is that it cannot easily justify the current policy of a zero interest rate," Bullard told a group of economists in Washington in October. "Strict inflation targeting may provide a reason to set the policy rate below its long-run level, but not all the way to zero."

An increase in short-term rates in the U.S., of course, will be felt well beyond its borders. That's got some investors worried that rising U.S. rates could throw even more cold water the global economy, especially in the developing world.

But those economies have also been healing since the worst of the 2008 financial meltdown, according to Shearing.

"Dollar debt burdens are lower than they have been at the start of previous Fed tightening cycles and balance of payments positions are — for the most part — more sustainable," he said. "This makes emerging markets less vulnerable to either a further rise in the dollar or any disruption global capital flows in the wake of Fed tightening."

Raising rates also provides the Fed with critical breathing room if the economy slows or inflation continues to weaken. One of the central bank's major quandaries since 2008 has been that — with short-term rates at near zero — it has few tools left to try to boost growth.

And for those still worried that higher interest rates spell doom for the markets and economy — take a closer look at other, market-driven measures of the cost of borrowing. Partly in response to the central bank's clear warnings this year that higher rates were coming, several key borrowing rates have edged higher, with no apparent ill effect.

So take a deep breath. If it weren't for all the headlines, you'd be unlikely to notice that the rate that banks charge each other to borrow money from one another went up by a quarter-point.