Your Federal Reserve Rate Hike Handbook: Dig In

Back in August 2015, research showed that 82 percent of economists predicted the Federal Reserve would raise interest rates in September. Those projections were proven wrong when the Fed announced on September 17th that due to market concerns, they would not change rates at that time.

They stated, “Recent information on real U.S. economic activity was generally stronger than expected, but equity prices declined, the foreign exchange value of the dollar appreciated further, and indicators of foreign economic growth were generally weak.”

Everyone has been watching the markets even closer since then. In the last few days, 97 percent of economists surveyed by The Wall Street Journal are expecting a rate hike this Wednesday, Dec 16. What is also interesting to note is that 82 percent of participants feel that the Fed could lose its credibility if it doesn’t raise rates in the upcoming announcement since the economy has improved and stronger job numbers have been released.

During the recession, close to 8.7 million job were lost in the U.S., but since then we’ve recovered 13 million. Just five years ago there were six unemployed workers for every job opening versus now there are only 1.5. Wages have also been increasing.

Source: WSJ

The Likelihood Of Multiple Rate Hikes

Even if the Fed does in fact raise rates this week, many economists anticipate a second interest rate hike towards the end of first quarter 2016 during the March 15-16 policy meeting. Janet Yellen and other top officials have commented on the importance of taking a gradual and cautious pace.

Historically, the Fed has raised interest rates in 25 – 50 bps increments over two-to-three year periods in order to give the markets time to digest the moves in an orderly fashion.

Source: The New York Times

What Does An Interest Rate Hike Actually Entail?

In order to understand why interest rates could rise, it’s important to understand why rates have been low. The benchmark Fed Funds Rate has not risen in about nine years, as you can see in the above chart. It was lowered close to zero in attempts to strengthen the U.S. economy after the financial crisis.

Low interest rates can stimulate growth in the economy by making it easier for corporations and consumers to borrow money. On the other hand, higher interest rates tend to slow down the economy as borrowing becomes more difficult.

Some of the affects Americans can expect with interest rate hikes include higher rates on mortgages, car loans, credit cards, CDs and money market accounts. In addition, lower consumer spending, home sales, borrowing, and business profits could all occur as people take a wait and see approach.

Global Impacts Of Rising Interest Rates

Did you know that market interest rates in the United Kingdom have historically moved in tandem with those in the U.S.? Mark Carney, the Bank of England governor said that they are likely to increase rates gradually. Analysts are predicting a UK rate hike in the late spring of 2016.

Source: Financial Times

Other countries may loosen monetary policy including Japan to try and bring their inflation levels back on target. Some investors predict China’s central bank could also cut rates to encourage growth.

It’s difficult to predict how emerging markets could react. Some may decide to lower rates to help their economies, or raise rates in an attempt to discourage investors from taking their money abroad. Higher interest rates in the U.S. typically lead to a stronger dollar, which can lower the value of emerging market currencies.

How Rising Interest Rates Can Impact Stocks And Bonds

Investors may see a slow down in the stock market after the Fed raises rates. But don’t let this cause you to panic; keep your cool in a rising interest rate environment. Although it’s impossible to know exactly how the market will react, the much anticipated rate hike is unlikely to cause wild volatility swings or a market crash.

Companies with high levels of cash and minimal debt can become more attractive in the short-term when interest rates go up. Large banks and brokerages may also benefit and insurance stocks could perform well. Sectors such as utilities, telecoms, REITs, and highly leveraged energy companies could take a hit, however.

Existing bond prices are likely to go down as rates rise since newly issued bonds with the same credit rating will have higher yields in comparison. Bonds with longer maturities are likely to be more sensitive to rate changes than those with shorter maturities since longer time horizons are more difficult to predict.

Staggering bond maturities and reinvesting the proceeds as each position matures, known as laddering, may be an effective investment strategy. Consider diversifying your fixed income portfolio to include a higher percentage of shorter duration bonds. Other investment options include holding existing positions to maturity, investing in fixed-maturity or floating rate ETFs, and buying Treasury Inflation Protected Securities (TIPS).

Stay On The Pulse

Be on the lookout for the Fed’s announcement regarding interest rates this Wednesday. Staying in tune with monetary policy and economic activity can help you become a more successful investor.

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