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Top 5 Losers When The Fed Raises Rates

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Top 5 Losers When The Fed Raises Rates

The U.S. Federal Reserve is widely expected to raise interest rates at its upcoming December meeting next week.

The bank has been discussing the possibility of a rate hike for the past year, leaving markets to guess when and how much the bank will decide to increase. While predictions for when a rate hike will happen have changed several times over the course of 2015, the majority consensus is that an increase will happen in December.

Why December?

At the Fed's last meeting, the bank released a policy statement naming its December meeting as a likely option for a rate hike. That was the first time the Fed's policymakers were so open about their future plans, leading traders to believe that barring any extenuating circumstances, the Fed had already decided to raise rates in December.

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Much of the data out since the November meeting has supported the prospect of a rate hike as well. While inflation figures have fallen short of the Fed's 2 percent target, other economic indicators have suggested that the U.S. economy is strong enough to withstand a rate increase. The November jobs report has been the most notable signal that a rate hike is imminent, as the report showed that employers added 211,000 jobs that month and that the unemployment rate was constant at 5 percent. Many analysts said the figure would have had to be below 80,000 for the bank to consider holding off on a rate increase.

With the majority of market participants expecting to see a rate increase this month, the biggest question has been what that will mean for investors. Although a year's worth of rhetoric leading up to this month's rate hike has helped markets price in the risks of a rate increase, some are still jittery about how the Fed's decision will affect traders.

Most don't expect the rate increase to cause a market Armageddon, but some negative effects are likely.

Here's a look at the five biggest losers should the Fed raise interest rates this month.

Emerging Markets

Perhaps one of the most talked about consequences of a Federal Reserve rate hike is a sharp blow to emerging markets.

So far this year, emerging market economies have struggled with currency pressures, and many believe that the Fed's decision to raise interest rates will further exacerbate those problems. Countries like Brazil and South Africa will likely find it difficult to navigate, as cash moves away from their economies and toward the United States.

Many firms in emerging market economies began borrowing large amounts of cash during the Fed's ultra-accommodative monetary policies. While Chinese firms led the charge, many EM firms over-borrowed excessively during the past few years in order to support rapid growth and take advantage of cheaper borrowing costs.

However, those decisions have taken emerging markets' corporate debt, as a percentage of economic output from less than half to nearly 75 percent over the past decade. That means when the Fed makes borrowing more expensive, those firms will struggle. The International Monetary Fund has warned that emerging markets may face a serious credit crunch following the Fed's rate hike.

Related Link: Macro Views Could Be Challenged, But Likely Set On Expected Fed Hike

Firms With Floating-Rate Debts

Companies with relatively high debt levels are likely to struggle come an interest rate rise, especially those with a large proportion of variable debt.

Variable, or floating-rate, debt means the firm's interest payments are aligned with market rates, so an interest rate increase will push up the cost of their debt. The financials sector tends to have the highest degree of floating rate debt, followed by industrials; so, firms within those arenas may be in trouble.

In September, Goldman Sachs released a list of stocks with high floating-rate debt in order to help investors prepare for the Fed's rate hike plans. M&T Bank Corporation (NYSE: MTB) topped the list with 29.5 percent of the firm's debt on a floating rate. Other finance companies with worrying floating-rate debt levels were Progressive Corp (NYSE: PGR) with 28.5 percent, Wells Fargo & Co (NYSE: WFC) with 25.6 percent and Lincoln National Corporation (NYSE: LNC) with 25.0 percent.

Ford Motor Company (NYSE: F) stood out in the consumer discretionary sector with a much higher floating debt percentage than many of its peers, and PACCAR Inc (NASDAQ: PCAR) appeared to be most at risk in the industrials sector with 24.3 percent of its debt linked to a variable rate.

Consumers

Many are worried about the impact the Federal Reserve's rate increase will have on consumers, as spending is a key part of the U.S. economy's strength, and added burdens on the U.S. public could throw the nation's economy off track.

The rate increase will have the largest impact on Americans looking to borrow for things like buying a house or a car, as the price of new loans will rise alongside the Fed's rate. For current homeowners who took advantage of the super low rates seen in 2014 and 2015, the rate increase may not have a significant impact, but for those whose mortgages are tied to a variable rate, the Fed's rate hike could drive their monthly payments higher.

To begin with, the Fed is only expected to raise rates by about a quarter of a percentage point. Such an increase is unlikely to have a detrimental effect on homeowners' budgets; however, it represents a shift from cheap borrowing costs to more expensive debt, something that could eventually change consumer behavior.

While it was cost-effective to purchase a house or other big-ticket item when interest rates were low and monthly payments were manageable, consumers may begin to tighten their purse strings in anticipation of a time when interest rates grow considerably. Much of how the rate rise will affect consumers will depend on the Fed's pace of interest rate increases over the next few years.

The initial rate hike will do little to burden the average consumer, but if the bank quickly adds further increases in the following months, it could become troublesome for American consumers.

High-Dividend Stocks

While high-dividend value stocks are often considered safe investments in times of market trouble, if the Federal Reserve raises interest rates, it could actually be a negative for stocks that pay high dividends.

Over the past few years, dividend stocks have been a popular choice for value investors looking for an investment that will generate a steady income. However, those types of stocks were popular due in large part to the fact that bonds were struggling. With an interest rate rise, bond yields are likely to rise, making them more appealing for investors than they have been over the past decade.

That kind of shift is likely to dull the shine of dividend stocks, as it provides investors with another relatively stable option. Companies most susceptible to such a shift will be those in the consumer staples and utilities industries.

Other Considerations

Of course, there is a wide range of possibilities that come with a Federal Reserve interest rate hike. If the bank does decide to raise rates in December, it will be entering uncharted territory, as no other central bank in the world has been able to successfully orchestrate a rate increase campaign.

Related Link: Options Outlook: Manage Open Risk Ahead Of Fed Meeting

Many believe that multi-nationals will also suffer, as their products will become less competitive due to a stronger dollar. Others say the U.S. government itself will struggle as the nation's debt becomes much more expensive. The Congressional Budget Office has predicted U.S. government interest payments could rise as much as $2.9 trillion over the next decade as rates rise. Some investors are preparing for another market meltdown, saying that a rate rise will be enough to spook traders and take share markets significantly lower.

However, on the other side, contrarians are gearing up for market panic, hoping to snap up bargain priced stocks when the rest of the market flees. They say rate hike worries have already been priced in, because of the bank's ongoing dialogue about raising interest rates. While an interest rate hike will have an impact on many S&P 500 firms, some say the Fed has given traders and businesses ample time to prepare for its next policy move, and any panic surrounding a rate hike is unnecessary.

Image Credit: By US Department of the Treasury [Public domain], via Wikimedia Commons

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