Friday, December 18, 2015

Fed Decision and its Impacts

After 6 years, Federal Reserves raised the Fed benchmark rate. While on one hand it signifies the fact that the underlying economy is doing well because of which Fed increased the rates, it also suggests that the market should embrace the new normal i.e. upcoming higher interest rates. Higher rates can impact many different walks of life ranging from savers to home owners.

Higher rates mean lower bond prices and could impact:
  1. Home buyers
  2. Credit Borrowers
  3. Real estate investors
  4. Savers
  5. Equity investors
  6. Bond investors
Although one can write separate blog posts for every individual class, the major theme will revolve around increased cost of credit. With increased borrowing cost, it will get difficult to buy homes, borrow for credit card purchases, borrow for investments in real estate or other venture, thus reducing the flow of money in the economy.

It will also encourage corporations and individuals to save and at some point make equities less appealing, as they will be able to get higher rates without added risk. Please don't get me wrong - savings are the engine of long-term economic development, while spending helps in the short-term.

Since the rates and prices move in opposite direction, rate increase by Feds means that bond prices will decline. However, contrary to this simplistic idea, UST's proprietary bond market analysis suggests that longer term bonds are still in a bull market. It is one of the 3 primary asset classes that is in a bull market.

Therefore, bond investors should not be scared by this Fed hike. Bonds will continue to do better for some time. This also flows well with our discussion on objective trend following, in the last blog post. Objective investing requires one to analyze asset classes holistically rather than event based analysis. And at this point, holistic picture based on proprietary indicators is suggesting that the bond market will do better. This could mean:
  1. Stocks are going to perform poorly to push interest rates down even with fed hikes
  2. Fed fund rate hikes will be in contrast to economic reality, and could result in yield curve inversion
Both of the above scenarios are bad for economy and investors. In the next few posts, we will discuss:

  • Detailed discussion on potential causes of bond yield decline even with Fed's increased rates
  • Alternative investments, according to their state - Part 2
  • Elliott Wave analysis of current stock market
  • Asset allocation options
  • Tax implications 
  • Revisiting Objectivity and market trend

  • Let me know if you think the best time to buy homes is about to come or has already passed?


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