Finally, the dovish voting members of the Federal Reserve come around to a rate hike. We don’t want to recycle our previous commentaries about this decision (If you would like to read our previous commentary there is a list below), so let’s consider a few new ideas.
First, who are the winners and losers from this decision? Who benefits from increasing rates? Most analysts suggest that the financial sector will benefit most. Greatly simplified, banks accept loaned money from the government (at the Fed Funds rate) and loan it out to the public at higher rates. So, you might think that banks have less of an opportunity to profit as the spread between those rates narrows, at least in the short term. However, the psychology of this situation is different. This move is an attempt to improve our monetary policy from a defensive, crisis-based stance to a more normalized posture. Once several rate hikes have occurred the next year or so, the possibility of longer term increase in borrowing rates can happen.
Who loses from the increase in rates? Borrowers, generally. More specifically, any company that needs short term cash, or refinancing. Again, we expect the yield curve to flatten in the short term; in other words, we don’t expect longer and medium term borrowing costs to change much. Low capital intensive industries like information technologies should be largely indifferent to the direct effects.
Another lingering question for bond investors is, why might you want to keep interest rate sensitive, high duration bonds in this rising rate environment? In terms of pure returns, high duration bonds are going to be negatively impacted for the foreseeable future. However, long term bond holders should be encouraged since returns are not the only reason to have bonds as a component of your portfolio. In short, high duration assets have been, historically, a great diversifier against equity risk. The profit based market expansion is now in its 7th year, and there is a potential for volatility in the equity markets. High duration bonds can add some inverse correlation – a little zig when the stock markets zag – which can soften the overall change in portfolio value.
Fed will not change rates in October 10/28/15
Waiting For you 9/23/15