By: Matthew DePompeo
On Wednesday December 14, the Fed chair Janet Yellen held a news conference announcing that the Federal Reserve is raising its benchmark interest rate. They raised the interest rate by 0.25%, this is only the second time that they have increased interest rates in a decade, the second of which being in December of 2015. What was the reasoning for the increase in interest rates? According to Yellen the Fed is recognizing the considerable progress the economy has made towards their dual objectives of maximum employment and price stability. They state the 4.6% unemployment and inflation rate raising to 2 % shows signs of a strong economy. What this essentially means is that the amount of money in circulation lessens, it also makes borrowing money more expensive and drives up costs for companies.
What does this mean for investors? Historically this makes certain types of investments more attractive while at the same time making others under-perform. Some investments that become more attractive are fixed income investments, this happens because in order to borrow money through fixed incomes the interest rate at which they borrow will be increased. With Fixed incomes already being known as a safe place for your money, increased interest rates make fixed incomes something to look at. For those investing in currencies increasing your holdings in the US dollar would be a good idea, the US dollar is already the preferred world currency increased interest rates usually attracts more foreign capital to investment instruments like T-bills, notes and bonds.
There are certain industries and types of stock that usually do well in times of increased interest rates.
The financial sector usually does well this is caused by increased loan rates. Other industries that do well are cyclical industries some examples of this are automobiles, fine dining, housing, and construction. When the economy is flourishing these industries do well because people have more money to spend on non-essential items.
There are some industries that will under-perform during times of an interest rate increase, such as highly leveraged businesses like telecommunications firms, utilizes, and real estate investments trusts. These companies need to take on more debt in order to borrow more money to support expansion. Also Blue-chip dividend payers can under-perform with the increase of interest rates. These stocks are usually seen as safe havens in times of uncertainty, so when the economy strengthens investors look for better returns that they may not be able to find with blue chip stocks.
Outside of investing rising interest rates will impact other aspects of your everyday life. Some less favorable impacts could be an increase in credit card interest rates, student loan interest rates, Refinancing rates, home equity lines, and auto loans. Some more positive aspects will be that increased interest rates will keep the inflation rate from raising, this preventing increased cost of everyday goods.
With all that being said this all must be taken with a grain of salt, increased interest rates are only one factor of many that affect the market, and the increased interest rate is relatively tame especially if you compare it to past increases (see graph above). According to JP Morgan Chase’s head economist, James Glassman “The Fed’s Policy will prolong the current business cycle and keep the economy operating at its peak potential for as long as possible. As we approach the current peak, slightly higher interest rate may effectively discourage the creation of asset bubbles and bad investments. “With a new year comes new change, but if the market is any indicator then the economy will have a strong growth year in 2017.
THE EFFECT OF INCREASED INTEREST RATES
By: Matthew DePompeo