- FOMC Board Minutes suggest potential interest rate rise next month
- Futures market pricing a 32% chance of a hike in June, compared to a 6% chance last week and a 4% chance a fortnight ago: markets expectations are adjusting accordingly.
- If rate hike becomes more likely, this is potentially negative for risk- and rate-sensitive asset, and gold. Positive for dollar, short-dated bonds and financials.
- Will Fed watch the economy, or the markets?
Fed Rate Hike Warning:
never say never…
Prospects of rising interest rates sooner than the market had
become ready to expect will pull away the prop for equities and hence negative equities. The S&P500 (NYSEARCA:SPY, NYSEARCA:IVV
(US); LON:CSPX (UK)) has dropped to
a seven week low, and is now flat on the year, weighing down global equities (iShares
MSCI ACWI Index Funds NASDAQ:ACWI
(US); Vanguard FTSE All World Index LON:VWRD
(UK)).
The increased chance of a Fed rate hike creates downside
risk at the long end of the yield curves (e.g. iShares $ Treasury Bonds 20+
year) NYSEARCA:TLT (US); LON:IDTL (UK)), and for corporate bonds
(e.g. iShares $ Corporate Bonds NYSEARCA:LQD
(US); LON:LQDE (UK)). Perhaps most at risk are high-yield bonds
with the double whammy of rate rises and on valuations where investor thirst
for income has led to yields being potentially over-bid (e.g iShares $ High
Yield Corporate Bonds, NYSEARCA:HYG (US);
LON:SHYU (UK)) . On the flipside, there is a potential offset
as the improving economic backdrop could make the case for tightening spreads.
Within the bond sector, shorter duration bonds will be less
exposed (e.g. iShares $ Treasury Bonds 1-3yrs NYSEARCA:SHY (US); LON:IBTS
(UK)).
An upward move in Fed Funds rate would be positive for the
Dollar and hence short-dated/ultra-short dated treasuries, as the ability of
earning risk-free returns on cash once again become a more likely prospect. (e.g.
iShares Short Treasury Bonds NYSEARCA:SHV
(US), PIMCO Enhanced Short Maturity Active NYSEARCA:MINT
(US); iShares $ Ultrashort Bonds LON:ERND
(UK))
On a relative basis, a Fed Funds hike may see relative
weakness in Gold (SPDR Gold Shares NYSEARCA:GLD
(US); ETFS Physical Gold LON:PHAU
(UK))
On a sector specific-basis, rising rates is a positive
indicator for net interest margins which is supportive for banks/financials (SPDR
S&P Banks NYSEARCA:KBE) (US); SPDR
S&P US Financial Select Sector LON:SXLF
(UK) FRA:ZPDF).
By contrast a hike would be negative for long-duration/rate-sensitive
sectors such as Utilities & Financials (Utilities Select SPDR ETF NYSEARCA:XLU (US); SPDR S&P US Financial
Select Sector UCITS ETF LON:SXLU
(UK) FRA:ZPDU).
Property/real estate sector would likewise be negatively
impacted as spreads between property yields over risk-free rate contracts: (iShares
Global REIT NYSEARCA:REET (US); iShares
Developed Markets Property Yield LON:IWDP
(UK)). On the flipside, any uptick in the economy could be an offsetting
factor.
Risk assets love the “lower for longer”
support of ultra-low interest rates.
Readjustment to rising costs of capital could be painful.
NOTICES: I/we have
no positions in any stocks mentioned, and no plans to initiate any positions
within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not receiving
compensation for it. This article has been written for a US and UK
audience. Tickers are shown for corresponding
and/or similar ETFs prefixed by the relevant exchange code, e.g. “NYSEARCA:” (NYSE
Arca Exchange) for US readers; “LON:” (London Stock Exchange) for UK readers. For research purposes/market commentary only,
does not constitute an investment recommendation or advice. For more information see www.elstonconsulting.co.uk
Image credit: DodgertonSkillhause http://dodger.isinthehouse.com/
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