News Details

Fed Rate Hike: Will they or will they not?
Sunday 15, November 2015

 It is anybody’s guess whether the Fed will raise its benchmark interest rate at its next policy meeting in a few weeks, December 15-16, 2015.  But recently, a survey of Bloomberg economists showed that 66% expect the Fed to raise rates at its December meeting.  This is an increase from 56% in July.  A later Wall Street Journal (WSJ) survey was much more convincing, with 92% of the economists surveyed by the WSJ betting on an increase in rates in December.

The economists are counting on a 271,000-job increase in October and the resultant 5% fall in the unemployment rate to validate their prediction.  The Fed has consistently said that it would monitor the economic indicators to determine whether the economy is growing.  The economists surveyed seem to think that the Fed has found this growth in the recent jobs data.  Janet Yellen, Fed Chairman, said recently (on November 4, 2015) that the economy is expected to continue to grow at a rate that is sufficient to generate further improvements in the labour market and to return inflation to its two percent medium term target.  The economists grabbed it and ran.  But Yellen continued that “ … if the incoming information supports that expectation, then … December would be a live possibility but importantly, we’ve made no decision about it …” (emphasis mine).  Nevertheless, despite the cautionary statement at the end, the rate hike is seen as a done deal by market participants.

The Federal Reserve Board has kept its benchmark interest rate at 0 – 0.25% p.a. for the past 7 years in an effort to stimulate growth within the US economy.  Over the years, the Fed has consistently said that when the economy shows signs of acceptable growth, rate increases would be considered.  This growth was predicated on certain macroeconomic conditions being in place before raising rates.  These conditions include ensuring that the jobs data are favourable; this means employment needs to be at an acceptable level.  Consideration would also be given as to whether the Fed’s inflation target was being met.  Market participants now contemplate whether it is the appropriate time to raise the rate. 

The two percent inflation target mentioned in Yellen’s speech on November 4, as well as the growth in the wage rate seem to be the main areas of discontent for those against the increase in the rate.  The arguments are that the wage growth is still below pre-crisis levels, that inflation is still below the Fed’s two percent target, and more importantly, that these levels were set too low from the beginning.  Consequently, the argument goes, the Fed should not be raising rates until these two indicators are at least back at their pre-crisis levels.

Proponents feel that the labour market is strong enough to withstand the increase and that furthermore, if this is not done, the Fed would be sending a signal that the economy is not as strong as it should be.

But what would be the effect of an increase in the Fed rate, and how will it impact investors?  On the release of the October jobs data last Friday, stocks began to sell off while bond yields were rising, as stockholders and bondholders anticipated an increase in Fed funds rate.

The general principle is that an increase in rates is bad for stocks.  One reason for this is that increases in interest rates can adversely affect corporate performance as the company grapples with the higher cost of debt.  Also, in periods of uncertainty, investors tend to abandon riskier investments, like stocks, for more secure assets.

Investments in bonds will initially experience a decline in prices because investors will now begin to demand higher returns and these higher returns will lead to a lowering of bond prices.  However, in the longer term, bonds tend to benefit from the fallout in the stock market.

Based on the reasoning for and against an interest rate increase and the effect it will have on the economy, I agree that it is not the best time for the Fed to embark on such an increase.  The economy is just recovering and an increase could effectively stymie further growth.  But as one proponent observed “it is a done deal”.

Pamela Lewis is Vice President, Investments and Client Services at Sterling Asset Management Ltd. Sterling provides financial and advisory services to the corporate, individual and institutional investor. Feedback:  If you wish to have Sterling address your investment questions in upcoming articles, please e-mail us at: info@sterlingasset.net.jm or visit our website at www.sterling.com.jm

Share |
Go Back to News Archive
Document Library

You may browse and download our Customer Forms, Articles and other documents here.

 

Faqs
  • Q: What products does SAM provide?
    A: At Sterling Asset Management we aim to help you maximize the return on your assets in a variety of ways. For the institutional...
  • Q: How easily can I encash all or part of my investment?
    A:  You may encash your investment at any time, however if you encash before the end of your tenure a penalty is applied.