Rate hike? Bring it on!

By Bill DeShurkoCovestor

The Federal Reserve kept interest rates close to zero again but said it would focus on its “next meeting” in mid-December on whether to raise interest rates.

Specifically they said they “…would determine whether it will be appropriate to raise the target range at its next meeting.”

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The reason this is important is that December is obviously the last month of the year, but specifically, this year it is the last month prior to the start of an election year.

Election Year

Despite the fact that the Fed is meant to be apolitical, they have historically tried to avoid policy changes in election years.

Part “B” to this is that the Fed desperately wants to raise the overnight rate from zero to something nominal like 0.25%.

Their thinking is that, should the economy slow, they need some ammunition (lower rates back to zero) to help stimulate the economy and stave off a recession.

I have firmly been in the camp for years that there would not be an interest-rate increase as the economy was just too soft to justify the action.

Cosmetic

Until now. While I still think the economy is soft, I also think a 0.25% increase is purely cosmetic.The Fed will move in December hoping that they can then get through an election year without further rate talk.

So while the media and pundits seem obsessed with the horrors of rising rates, what does it really mean to the average investor, especially retirees on a fairly fixed income?

Here are some reasons to embrace the (presumed) latent Fed action.

  • Higher rates are usually viewed negatively in terms of consumer borrowing. But lenders look at it differently — with higher interest rates, they are paid to take on credit and inflation risk. Simply put, why in the world would a bank want to give out a 30-year mortgage at less than 4% interest under any circumstances, let alone to someone with less than “perfect” credit? And with the future of inflation being unknown (other than presumably higher due to Federal Reserve stimulus), 4% just doesn’t warrant the risk.

Reason 1: We may see more bank lending, not less, as banks actually lend. This could be the shot in the arm the housing market needs to take off. In my opinion, the market will see things differently and punish housing stocks on the news. Be smarter than the street. Buy on the dip.

  • Low-return, but safe investments become profitable when purchased with borrowed money, if the cost to borrow is extremely low. Large Investors can use algorithms to make pennies on a trade, but if done frequently with borrowed money, they can turn mediocre returns into very high returns quickly. This will end with higher interest rates and is why the market has a hissy fit whenever a Fed member gives a hawkish speech.

Reason 2: There is no question that volatility has increased over recent years due to High Frequency Traders (HFT) and hedge funds taking advantage of low rates and frequent algorithm-based trading. Higher interest rates will end some of this, hopefully eliminating some of the extreme volatility we have now. Retail investors will be able to invest with more confidence in their decisions as (hopefully) fundamentals will regain importance.

  • Higher interest rates will support demand for the U.S. dollar from foreign investors continuing to push the dollar higher.

Reason 3a: The price for imported goods will continue down. A higher dollar will also help keep a lid on oil prices when they start to reverse in 2016-2017. This should help soften the blow from your lack of Social Security raise.

Reason 3b: Emerging markets will likely get hammered even further. Yes, this could be a good thing unless you have been convinced that a buy and hold and diversify into everything strategy is the way to go. (I believe it’s not).

As a retiree there is absolutely no reason you should own any emerging-market funds or ETFs, in my opinion. The only people who think so are mutual-fund companies that make money from investors in their emerging-market funds.

But that doesn’t mean there won’t be opportunity in the future.

If you’re astute, or have a good advisor, good money may be had closer to 2017 with a little speculative investment in emerging markets. Write this down: Sovereign debt of emerging-market countries will be the talk in 2017 if the Fed does raise rates.

  • In theory, if interest rates rise on things like bank accounts and Treasury bonds, investors will discard their 3.5% yielding stocks for 1% yielding savings accounts (yes economists actually think like this), and these wonderful dividend-paying stocks will take another hit before year end.

Reason 4: If you are fully invested now, I believe you should take advantage of this rally and sell some of your winners, raise cash. If I’m right, you will be able to pick up some really great stocks a little cheaper after the first of the year. If you have a lot of cash, be patient. And a tip: Follow your stocks up with stop-loss orders.

And finally the obvious:

Reason 5: You might actually be able to get 1% interest on the savings you have in the bank. Seriously, it makes a difference. Maybe not directly to you, unless you have a million or so in the bank, but think of it this way: there is over $8 trillion dollars in savings deposits in the U S. If banks have to pay out half a percent more in interest, that would be an increase of $40 billion dollars. That money could find its way into the economy and cumulatively give the economy a boost.

So don’t fear the Fed. If played properly, a Fed move could benefit your long-term retirement outlook.

Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. Covestor believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.

 Photo Credit: Day Donaldson via Flickr Creative Commons//

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