This month, the policymaking Federal Open Market Committee meeting, as widely expected, unanimously held federal funds rates steady at the range of 2% to 2.25%. The Rates has remained at highest levels after the collapse of Lehman Brothers since October 2008.
Federal Reserve System, has offered a mostly upbeat assessment of the U.S. economy, indicating another rate hike by the end of the year. At the year’s final meeting, Traders in the fed funds futures market have implied about a 92% probability for a hike. The Fed had earlier forecasted three rate hikes for the next year.
The Fed did mention that “economic activity has been rising at a strong rate and that the labor market has continued to strengthen,” which could easily offset concerns about soft spots in the economy. The Fed acknowledged slowdown in business investment but echoed its previous assessment of consumption, which accounts for 70% of the economy by saying that household spending “has continued to grow strongly.”
Winners & Losers in a Rising Rate Environment:
Certain sectors stand to gain and some set to face an uphill task, with the Fed raising the interest rates and the rates set for a hike quickly.
Let’s take a look at the sufferer’s first –
In rising interest rate scenario, Investing in utilities won’t be a good idea. Utilities have high debt as these are capital intensive and huge funds are required to meet it. Funds generated from internal sources do not always meet such huge requirements. Low-interest rates help to pay off debts and book profits.
The credit ratings of these utility operators get impacted with higher rates escalating the debt level, for that matter a steep debt/equity ratio. If ratings go down, a company will find it difficult to borrow funds from the markets at reasonable rates, leading to a rise in the cost of operations and debt.
High federal funds rate make it expensive for banks to borrow money, which eventually translates into higher borrowing cost for customers. This is not a good thing for real estate activities business, for sure affecting construction-related businesses, like homebuilders.
Gold doesn’t offer high yield as compared to other safe investments like bonds. Rising rates decreases the appeal of precious metals.
High-interest rates boost the dollar and dent demand for dollar-denominated commodities. So which areas are set to make the most of a rate hike? It’s, financials!
High-interest rates boost bank profits as they increase the earnings of the bank by funding longer-term assets, such as loans, with shorter-term liabilities. Banks are definitely preferred for trade now.
National banks like the Bank of America Corporation are very rate-sensitive and have consistently seen earnings rise on a quarter-point rate hike.
The relation between interest rates and insurance companies is directly proportional, meaning high the rate, greater the growth. Few companies in the insurance industry root for a rate hike.
Insurers get their investment income from investing premiums received from policyholders in corporate and government bonds. Yields rates, coupons on these bonds rise with rising in Fed fund rates and bank interest rates. It enables life insurers to invest premiums at higher yields and earn more investment income, expanding their net profit margins.
Along with investment income, which is an important part of insurers’ top line, annuity sales also benefit from a higher rate environment.
Brokerage firms gains and have an advantage from an increasing rate since a hike in rates generally occurs during periods of economic strength and upbeat investor sentiments.
A wealth management firm like The Charles Schwab Corporation has said time and again that each quarter-point increase in rates generally adds to interest revenues, much of which flows directly to pre-tax profits.
Sum and Substance
With the Fed aiming for more rate increases this year and beyond, financials are definitely the go-to rate trade for now.
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