What do These Rate Hikes Mean for You?
The FOMC meeting concluded with the Fed approving the first rate hike of 2022 at +0.25%. They also indicated support for six additional rate hikes throughout the duration of 2021.
This month’s rate hike is the first increase to the federal funds rate since December 2018. Interest rates have stayed close to zero since the onset of the pandemic, but those rates will now see increases between 0.25-0.50%. The Fed hopes to reach a consensus rate of 1.9% at the end of 2022.
In addition to raising interest rates, the Fed anticipates reducing its $9 trillion balance sheet. JPow indicated that trimming the Fed’s fat balance sheet could begin in May, and it could act like an 8th rate hike. The FOMC shared:“[The Federal Reserve] anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee expects to begin reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities at a coming meeting.”
The committee also adjusted its inflation estimates for the year, with personal consumption spending (not including food/energy) +4.1% in 2022. That’s a significant increase from December’s estimate, where spending was anticipated to increase by just 2.7%. 2022 GDP estimates reflect a lower GDP, reduced to 2.8% from 4% in December. The FOMC sees a 3.5% unemployment rate by EOY.
What do these rate hikes mean for you?
- The Federal Reserve controls the federal funds rate, which is the target interest rate at which commercial banks can lend their reserves to each other. A bank's reserves describe the cash that banks have to keep in actual vaults to make sure they have enough liquid money to satisfy a large withdrawal. The federal funds rate is important because it affects unemployment, economic growth, and inflation in the U.S.
- The federal funds rate affects other interest rates that you may be familiar with, such as interest rates on home or auto loans. Why does this relationship exist? Well, the interest rate at which you have to pay back your car loan depends on the bank's individual rate for you (this is known as the prime lending rate), and your individual rate is directly related to the federal funds rate.
- You probably heard that the Fed is going to reduce its balance sheet and raise rates. When the federal funds rate is low, it encourages people to invest or take out loans (because you have less interests to pay back.) That’s why the Fed lowered rates during the pandemic in an effort to incentivize people to participate in the economy in spite of lockdowns. The Fed also started buying bonds and other securities — ‘increasing the size of its balance sheet’ — in a process called quantitative easing to help lower interest rates.
- Although lowering rates and increasing asset purchases was an appropriate short-term monetary response to the pandemic-era economy, low rates and printing lots of money causes inflation in the long run, which is where we are now.
- So if raising rates helps combat inflation, why is the stock market reacting negatively? Because higher interest rates raise borrowing costs, disincentivize hiring, increase credit card rates, and generally slow down the economy (at least, temporarily.) And when the economy slows down, bonds become more appealing investments because they’re less risky — so investors are selling or switching to bonds to avoid losing money.
Free money from the Fed has been amazing for the stock market. Zero percent interest rates depress government bond rates, essentially forcing investors to bet on risky assets like stocks. Higher rates could be a challenge for the stock market, too, which has become accustomed to -- if not addicted to -- easy money. Markets have already experienced significant volatility amid concerns about the Fed's plan to fight inflation.
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What do These Rate Hikes Mean for You?
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Oil, Agriculture, Natural Resources and Gold are the new FANG. Rate Hikes mean switching to stocks or ETFs that will include the above sectors.
There is also a current rotation from Growth stocks to Value stocks.
Therefore my portfolio will include
$Energy Select Sector SPDR Fund(XLE)$ which represents 40 of the largest US companies dealing in the Energy sector like Exxon Mobil and Chevron
$BetaShares Global Agriculture Companies - Currency Hedged(FOOD.AU)$ which tracks a basket of agricultural companies ex Australia
$SPDR Portfolio S&P 500 Value ETF(SPYV)$ which represents companies like Berkshire Hathaway, Bank of America, Procter & Gamble
$STI ETF(ES3.SI)$ which has 44% rating of the 3 local Singapore banks.
$Ishares Core S&P/Asx 200(IOZ.AU)$ which tracks Australia's biggest companies. These include BHP GROUP, Commonwealth Bank. Australia is a net exporter of Commodities and will greatly benefit from the supply crunch.
@MillionaireTiger Rate Hikes
@TigerStars
Rising rates mean I have to adjust my investment portfolio to allocate more to sectors or ETFs that benefit from higher rates and reduce portion in negatively impacted sectors.
Allocate more to:
Banks and financials as they are in business of lending money, higher interest increases margins. Bet on $Financial Select Sector SPDR Fund(XLF)$ or top banks in S'pore e.g $UNITED OVERSEAS BANK LIMITED(U11.SI)$ $DBS GROUP HOLDINGS LTD(D05.SI)$
Health care $Health Care Select Sector SPDR Fund(XLV)$ as consumers still need to get medicine and seek consultation in good and bad times.
Consumer staples $Consumer Staples Select Sector SPDR Fund(XLP)$ as housing, food and daily essentials are necessities still needed for living.
Reduce allocation to speculative Growth and Tech stocks with large debts and borrow to fuel growth. Rising rates make borrowings more expensive, curtailing their upwards ambition.
Looking at recent history of rate hikes from 1999 shared by author, we see similar pattern where 12-months after initial hikes, S&P performance increased 5.2% to 9.1%, with median of 5.6%. While banks raise interest rates, it’s unlikely bank deposit interest rates nor CPF (in Singapore) will reach such level.
Thus, important to remain invested in the Markets with quality stocks or ETFs as the returns will be greater than other instruments. Do determine fair price to enter and exit stocks, to not ‘buy high and sell low’.
Raising interest might increase loan so do re-pricing or reduce debts.
Lastly, stay invested and keep a look out for gd companies.
when prices are red hot like the 8%
inflation that drives prices up. I'll continue
to buy small quantity regularly & $ cost
averaged my investment to ⬇️ risk.
Macro economic impact - lending returns better rates. More tech companies will venture into financing and credit. Lowering the cost of buisiness and inproving quality.