Interest Rates and the Federal Reserve

First of all it is well noting that higher interest rates translate into higher costs for businesses to borrow and can lead to currency appreciation which is in turn disruptive to a country’s manufacturing industries. Higher interest rates also affect consumers which has less disposable cash to spend in recreation and retail as their money is consumed by higher mortgage repayments.

Just about everyday, there is a release of some economic number or news. I always tell people that if I knew the number before the release, I would not do anything different since I never know how the masses will react.

An announcement from the Federal Reserve that USA interest rates will be kept low for the next few years is likely to be bullish for the USA stock market and the wider global markets as a whole. It is also likely to push USA bonds higher (lower yields) and lead to a sell-off in the USA dollar.

This past week when the FOMC meeting was complete and the announcement came as expected that the Fed was leaving interest rates unchanged; the Dow dropped over 180 points in less than 2 hours. The bond market sold off too.

Why did so many people sell? The reason, according to the analysts, was the language the Feds used in their statement. The statement said that the Fed “can be patient” about raising interest rates but decided it could no longer say it would hold rates down “for a considerable period.” In other words, somewhere, sometime, interest rates will rise, the Fed was saying. And don’t say we didn’t warn you.

Now let’s think about this. Unless you are totally cut off from all forms of communication, you know that interest rates are at 45 year lows and everyone on this planet realizes that at some time in the future, rates will have to rise. The Fed just confirmed this.

Comments by the equity strategists were divided about whether this meant a complete reversal for the stock market or just a slight shift in market psychology. Interest-rate driven stocks, like housing companies, were getting dumped, while the heavy industry sector held up.

Is there anyone on the planet that felt that 1% Fed funds rate would exist forever? The fact that the Fed feels that the economy is in good enough shape to return interest rates to a more normal level is encouraging. One of the beneficiaries of this move can be the dollar. A few weeks ago I wrote about the dollar stability and the possibility of a reversal in the dollar to the long side. As of this newsletter, we are even closer. A stronger dollar is good for consumers. Consumer stocks held up well after the Fed announcement and in the following days. Basic material stocks held up well showing that a stronger economy is in place. Although interest rates may rise, many areas of the economy and sectors will benefit.

Rising interest rates do not mean an end to rising stock prices for every aspect of the stock market. Most of my work involves trend following in asset classes that are performing better than other asset classes of the economy. Watch in coming weeks to see how the dollar, interest rates, and more importantly how various asset classes perform. Also watch to see if the S&P 500 and Nasdaq 100 can stay above their 50 day moving averages. The 50 day moving average is my definition of trend. For now, the Dow, S&P 500 and Nasdaq 100 are all above their 50 day moving average.

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