US Federal Interest Part 2

US Federal interest impact – How does it affect the economy and most importantly, us as Investors (part 2)

Most of us know that a rate hike will come and the bull market will stumble, bond yields will climb and the economy will slip into a recession.

What we don’t know is how long all of that will take and how long it will last.

For the economy specifically, history offers little guide about timing. A recession has come as quickly as 11 months after the first rate hike and as long as 86 months.

Expectations are rising for the Fed to raise rates in its next meeting in December

The US economy created a lot more jobs in October than economists had forecasted. This suggests that the US economy is getting stronger and, combined with upbeat comments made by the Fed after its October meeting, is causing more people to believe that there will be a rate rise in December.

If that does happen, it will be the first US rate rise since 2006.

 

What does the market “think”

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Economy :

 

How does a rise in central bank interest rates get transmitted to the wider economy?

Adjusting the federal funds rate – the rate banks charge each other for short-term loans – affects other short term rates paid by firms and households. These movements also have knock-on effects on long-term rates, including mortgages and corporate bonds. Changes in long-term rates will have an influence on asset prices, including the equity market. During the crisis the Fed also purchased longer-term mortgage backed securities and Treasury bonds to lower the level of long-term rates.

Are businesses ready for an increase in borrowing costs?

Many corporations have taken advantage of the low rate environment to borrow money via the bond markets. Most companies say they are relaxed about the impact of a small rate hike, believing the market has already priced their bonds or such an event. However, some economists say the interest payments for companies who have issued low-grade debt could rise more quickly.

 

What are zombie companies and why are we concerned about them?

Zombie companies are enterprises that have been able to stay in business primarily because of the persistence of ultra-low interest rates, and which would be unable to survive a rate hike. Many of these companies will go under when their borrowing costs rise, but some, such as “bond king” Bill Gross, think this could be a good thing. They argue that when weak companies file for bankruptcy, their owners and employees often go on to work for more successful ventures, which is ultimately a good thing for the economy.

What will a rate rise mean for my personal finances?

An upward move in short-term interest rates will be positive for savers who have been missing out on interest on their deposits. But the change could also be transmitted to a range of other interest rates, including car loans, credit cards and mortgages, which would make them more costly.

Are US consumers in general prepared for rates to rise?

The burden of household debt has fallen since the crisis, reaching 114 per cent of net disposable income last year, according to OECD statistics, suggesting consumers are better prepared for higher borrowing costs. In addition, a quarter-point hike would still leave rates at historically low levels.

 

GDP

Recessions are a fact of economic life, but rate hikes often help them along.

In the current case, the Fed is facing some conditions that did not exist before and could hasten a recession. Most notably, gross domestic product will be near its lowest point ever for a Fed rate hike.

 

Why would a rate rise in the US impact the emerging market countries?

We have already seen the antecedents of the main impact: a stronger US dollar, backed by higher US interest rates, tends to depress the values of emerging market currencies at a time when many EM economies are already weakening and their currencies have already slumped against the greenback.The Fed’s rate rise could exacerbate the EM currency turmoil, and even help precipitate a full-blown crisis.

Investor:

How are currency traders positioning themselves in the anticipation of rate rises?

Currency markets are fickle, but differences in interest rates tend to drive movements in the longer-run. For example, if a European investor can borrow cheaply in Berlin and buy a higher-yielding US bond, then all else being equal the dollar will rise versus the euro. As a result, the dollar started the year in rip-roaring fashion, with an index measuring the US currency against a basket of its peers rocketing to a 12-year high, as investors bet on the Fed tightening monetary policy and bond yield differences widened.

Since then it has continued to beat up emerging market currencies but the broad rally has fizzled out as the euro and the Japanese yen have regained their footing. However, many analysts and fund managers expect the greenback to continue to climb higher in the coming years, as the Fed raises interest rates further.

What investments are most sensitive to interest rate rises?

Almost every asset class on the planet exhibits some evidence of frothiness these days, but some seem more vulnerable to higher interest rates. Although stocks look expensive, higher interest rates indicates that economic growth is firm, and that is good for listed companies. Gold typically loses its shine when interest rates climb, as the metal doesn’t pay any interest like a bank account will, but has already been beaten up heavily recently. The bond market looks more exposed. Highly rated debt is trading with very low yields, which means they are vulnerable to even a modest rise in Fed interest rates, while bonds issued by companies rated “junk” could suffer if more expensive borrowing tips some weaker groups into bankruptcy.

 

Stocks

High Debt Company with low cash flow and stagnant revenue grow will face issue. Most of this type of stock price will plunge before fed interest hike. The support will only come back if it plunge more than 20% (judge from 200MA) and it depends on case by case basic. If fed interest hike on Dec. The upcoming quarterly annual report or the next one will give traders and investor a picture of the company fundamental. If debt affect respective company overall profit, the share price will adjust accordingly. If respective high debt stock is oversold and undervalue, support will come and rebounce the share price or stabilize the price or slow down the plunge.

Bonds

As we all know interest rate and bond price always have inverse relationship. The drop of the price normally will take effect before the fed interest hike as the market anticipate and adjust accordingly… but this depend on what type of bonds too. Normally low yield bond will be the one being affected. While high yield bond will be in demand and increasing in price. US Corporate bond will  be greatly affected as consumer now can go for government bond as the later product that release or some existing will undergo yield adjustment that will be more attractive than some corporate bond yield.

Conclusion

Broadly speaking, companies that do the majority of their business in the U.S. will win as interest rates rise and local products become more attractive. Multinationals with lots of debt will fare worse, as a rising dollar makes their products more expensive in the global market space and their debt more expensive the finance.

“History shows that ‘quality’ stocks tend to outperform during the three months following an initial rate hike,” Goldman Sachs analysts said in a report for clients. “Firms with strong balance sheets outpaced weak balance sheet companies following each of the 1994, 1999, and 2004 rate hikes, by an average of 5 percentage points.

“Companies with high returns on capital as well as low volatility stocks also outperformed their lower quality counterparts, by an average of 4 (percentage points) and 3 (percentage points), respectively.”

Debt will become a big issue. Companies with a high percentage of floating rate debt stand to lose the most, Goldman said.

Outside pure stock plays, consumers stand to benefit as well through the rising dollar. Savers could see gains as well through higher yields at the, though experts differ on how quickly that will take hold.

One interesting point to take note is that market react quickly on the beginning of the Nov and mid of Nov then recover all the losses…expected end of Nov and beginning of Dec the market will quite stagnant and anticipate the fed interest how many basic will be increased. Traders might choose to start the bearish cycle on 1-2 weeks before the interest hike or they will push the share price higher…if the basic point increase is more than 100…then they might try to plunge the share price drastically.

If not, little increase of the basic points will lead the traders to continue stock rally until next point of fed interest increase…market confidence will be back and stock will continue to recover and undergo sideway…

The real plunge might be delayed until the next quarterly annual report…or the annual report on mid of 2016 when we are able to see hows the company doing financially through their financial reports.

My take is mid to late Dec 2015 the bearish cycle will continue and by mid of 2016 the stock market will undergo 50-70% plunge. Of course this is just my daring assumption and opinion.

 

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