The Fed is Ready for Take-off
It seems nearly impossible not to have heard that the Federal Reserve (Fed) has started raising rates. Technically, the Federal Reserve raises the Federal Funds Rate. That is the rate that the Fed charges commercial banks (Citigroup, Bank of America, etc) when they are borrowing or lending their excess reserves to each other overnight. This in turn can have a significant impact on consumer loans and credit cards. Within this article, Mark Scher, Senior Wealth Manager, discusses the effects of increasing interest rates.
It seems nearly impossible not to have heard that the Federal Reserve (Fed) has started raising rates. Technically, the Federal Reserve raises the Federal Funds Rate. That is the rate that the Fed charges commercial banks (Citigroup, Bank of America, etc) when they are borrowing or lending their excess reserves to each other overnight. This in turn can have a significant impact on consumer loans and credit cards.
The U.S. Treasury yield curve is used as the benchmark for the credit market because it displays the yields of risk-free income instruments over a range of varying maturities. As stated above, when the Fed raises the Fed Fund Rate, credit markets, banks, many lenders will use the Treasury yield curve to determine lending and savings rates. Therefore, when the Fed raises rates, all lenders tend to do so in unison, although the rate increases will likely be inconsistent across market participants.
As we have seen over the past decade or so, low interest rates and massive fiscal stimulus drove investors to riskier assets such as stocks. However, when there is an alternative investment that provides a higher return than previously with less risk, investors will recalculate their risk position. When the Fed met on the 15-16 March 2022, they decided to raise rates by 0.25%. This was the first of potentially six rate increases as stated by Jerome Powell, Chair of the Federal Reserve.
What happens to stocks with interest rate increases? Historically, the lead-up to the increase is a difficult time in the equity markets. We have certainly seen the signs of that; however, when rates are increasing, it has generally been good for stocks, all else being equal.
The chart above shows that initial rate increases by the Fed have had positive impacts for both stocks and bonds. Intuitively, if the Fed is increasing rates, that means the economy is doing well. The increases are to slow, not stop, the economy. What we have seen in the US is exactly that; an economy that is robust, even in the face of higher inflation.
In the lead up to rate increases, we find that growth stocks tend to be hit harder than value companies. Growth stocks (typically Tech stocks) are characterized by higher price-to-earnings (P/E) ratios. As rates rise, future growth is discounted back to the present value and would therefore, be worth less. This is the exact reason the NASDAQ (Tech heavy index) is off -12.10% (as of 28 Feb 2022 according to Yahoo finance) and the S&P 500 is down -8.23% (as of 28 Feb 2022 according to Yahoo finance) for the year-to-date.
As is the case in any market convulsions, it is imperative to rely on your investment plan and ensure you are in a well-diversified portfolio. It is impossible to game the market and no one person knows which sectors, styles or factors will out- or under-perform and for what duration. Therefore, diversification rules will be the guidepost for a successful investment journey.
This document is intended for the recipient only. It may not be copied, forwarded or otherwise distributed, in whole or in part, to any other party without our prior consent. This document is intended for clients of MASECO LLP and those who have expressed an interest in its investment services.
- Nothing in this document constitutes investment or any other type of advice and should not be construed as such.
- The investments and strategy noted in this document may not be suitable for all investors and making available the information in this document is not a representation by MASECO that any investment strategy is suitable for any particular client.
- This document is provided for information purposes only; is not intended to be relied upon as a forecast, research or investment advice; and does not constitute a recommendation, offer or solicitation to buy or sell any products or to adopt an investment strategy.
- The views expressed herein do not necessarily reflect the views of MASECO as a whole or any part thereof.
- All investments involve risk and may lose value. The value of your investment can go down depending upon market conditions and you may not get back the original amount invested. Your capital is always at risk.
- Although the information is based on data which MASECO considers reliable, MASECO gives no assurance or guarantee that the information is accurate, current or complete and it should not be relied upon as such.
- Past performance is not a reliable indicator of future results.
MASECO LLP (trading as MASECO Private Wealth and MASECO Institutional) is established as a limited liability partnership in England and Wales (Companies House No. OC337650) and has its registered office at Burleigh House, 357 Strand, London WC2R 0HS. The individual partners are Mr J E Matthews, Mr J R D Sellon, Mr D R B Dorman, Mr H Q A Findlater, Mr T Flonaes, Mr N B Tissot and Ms A L Solana. Telephone calls may be recorded for your protection.
MASECO LLP is authorised and regulated by the Financial Conduct Authority for the conduct of investment business in the UK and is registered with the US Securities and Exchange Commission as a Registered Investment Advisor.