Making Sense Of The Fed's October Meeting
The US Federal Reserve decided to keep rates unchanged during its October policy meeting, but in a statement issued by the bank, it sent its strongest signal yet that a rate hike could happen in December. The news was quickly absorbed by markets, which have been hanging on the Fed’s every word for months in hopes of more clues about the bank’s interest rate plans. In the wake of the meeting the dollar gained strength and US stocks ended the day on a high note, leaving investors to wonder— what now?
In previous meetings, the Fed has expressed concern regarding the state of the global economy and US inflation. Those factors have kept the bank from raising rates, but at the October meeting the nation’s central bankers said worries about the turbulence in financial markets around the world had eased, suggesting that a rate hike is in the cards. The bank also specifically mentioned its December meeting in the statement, saying that the bank will have the data it needs to asses whether or not it will be time to raise rates. Following the statement, futures contracts showed that investors saw a 43 percent possibility of a December rate hike, a significant increase from the 34 percent chance seen before the meeting.
To Hike Or Not To Hike
While the bank’s wording was certainly more specific than it has been in the past, some analysts are hesitant to bet on December for a rate hike. US inflation is still below the bank’s 2 percent target, something Fed Chair Janet Yellen said would be an important factor in her decision making process. However, the bank has said that if inflation appears to be moving toward the 2 percent mark, it would have no qualms about raising rates before inflation has reached the Fed’s aim.
Does It Matter?
The Fed is heading into uncharted waters by raising interest rates after such a long period of ultra-low rates. To date, no central bank has successfully increased interest rates following such a long period of accommodation, so markets are understandably jittery about the repercussions. To combat market turmoil, the Fed has promised to raise rates slowly with only minor increases at a time and many investors say this process is likely to mute any negative effects. As traders have been discussing an interest rate increase for nearly a year, many believe that fears are overdone.
How To Prepare
While a rate increase may not cause a total market melt-down, It will probably have some consequences on markets and investors would be wise to prepare for the aftershocks.
With the Fed dominating the headlines, it may be easy to lose sight of what matters. Companies with strong financials are likely to weather whatever storm a rate hike may bring and uncertainty has left investors with several low-cost options. The most recent market correction has brought down share prices for many big-name firms in sectors like technology and health care, where demand is likely to continue despite the Fed’s policy changes.
Think Outside The US
Now may be an ideal time to start diversifying with international investments. While the US central bank is tightening its policies, others around the world are moving in the opposite direction. The European Central Bank has been injecting funds into the bloc’s economy for nearly a year and the bank is expected to continue doing so through next year, making Europe a good place to look for higher returns. For investors with an appetite for risk, emerging market economies could be a good bet as they are likely to recover and grow rapidly over the next 10 years.
Bonds To Suffer
Bond funds are likely to suffer when the Fed raises rates as bond prices and interest rates have an inverse relationship. Rising rates will probably make bond funds less valuable, though individual bonds with set maturity dates may not feel such strong effects.
Stocks That Will Survive
When the Fed raises interest rates, some firms are likely to perform better than others. Many believe that dividend stocks may take a hit while growth stocks could gain value. That’s because high growth stocks benefit from an improving economy and dividend stocks will loose some of their appeal with other income options out there. Another factor to consider is the amount of debt a company is carrying as a rate increase will suddenly make outstanding loans more expensive and eat away at margins. For investors looking to profit from a rate hike, the financial sector is a good place to start looking as banks will be the most direct beneficiaries of a rate increase.
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