Fed Raises Rates: What’s Next?

In mid-December, the Federal Reserve announced the first rate hike in nearly 10 years. Here are four things to keep in mind.

1.	The first rate hike usually indicates economic improvement, not an imminent market downturn.

It’s important to keep in mind the context of today’s action. Historically, the first Fed hikes have not precipitated economic or market downturns. Typically, the first rate increase has been a signal that the economy has gained traction, and on average, asset markets have typically performed relatively well in the year or two after the first hike.

2.	This round of rate hikes may be gradual.

This round of rates hikes is starting as the Fed faces a far weaker backdrop for global growth—as well as much lower inflation—than is typical for the first rate hike in a cycle. This would seem to imply the Fed will move forward at a gradual pace of tightening. This weaker global and inflation environment makes a dramatic spike in interest rates less likely.

3.	Higher rates could pressure commodities and emerging markets.

It is important to keep in mind that Fed monetary tightening does tighten global dollar liquidity as well. Because the dollar is the world’s reserve currency, this tighter liquidity has made it more difficult for many asset prices in recent months—including emerging-market equities, non-U.S. currencies, and commodity prices. These markets may remain volatile in the aftermath of the Fed’s first hike.

4.	The economy could stabilize.

Finally, our outlook is that the global economy will digest the Fed hike over the coming months. The rate increase may even boost confidence in the U.S. economy by reassuring us all that we are finally on a path to normalization. And with the U.S. still in a steady mid-cycle expansion, we expect the global economy to stabilize over the course of 2016. Markets are likely to be choppy, but overall I think the outlook for equities should be relatively favorable as the year unfolds.

https://www.fidelity.com/viewpoints/market-and-economic-insights/fed-raises-rate?ccsource=email_weekly

© 2015 These presentations are provided for informational purposes only. Read relevant legal disclosures.

Historically, What Do Stocks Do Before And After The Fed Starts Hiking Rates?...

Sooner or later, the Federal Reserve will begin normalizing monetary policy, which means higher interest rates are coming.

This has investors rightfully worried because higher rates mean higher interest costs, which should be bad for profits and ultimately stocks.

Deutsche Bank Chief US Equity Strategist David Bianco examined the history of Fed rate hikes and their impacts on stocks.

"Stocks typically sell-off on the first of a series of rate hikes, but the magnitude and duration of the sell-off depend on conditions," Bianco writes. "During early cycle hikes the initial sell-off was generally small, quickly recovered and further S&P gains came in next three months and longer (like 2004, 1983, 1972). But many sell- offs on late cycle hikes became corrections or even bear markets."

Unfortunately, it's only in hindsight do we know where we are in the cycle.

"Determining whether it’s early or late in the cycle is subjective, but the shape of the curve, inflation measures, years since the last recession can help," Bianco said. "Next year is likely another mid-cycle year and we don’t expect a severe S&P reaction to hikes, but the risk is the Fed hikes too late or too little and inflation accelerates requiring the Fed to hike to levels higher than expected."

Bianco's 27-page research note is riddled with exhibits. But we thought this one was pretty elegant.

It's the average price move of the S&P 500 during the 4 months before and the 6 months after the 1st rate hike. It's the average of the last 7 hikes.

It's not the most helpful chart for people who enjoy obsessing over the details. It does, however, show that the general direction of the stock market tends to be up.


Read more: http://www.businessinsider.com/how-stocks-move-around-first-fed-rate-hikes-2014-9#ixzz3EMoczX9P

The Federal Reserve Is Abysmal At Forecasting GDP Growth and Inflation...

Bond Yields Suggest 60% Chance of Recession...

The bond market indicator that has predicted every U.S. recession since 1970 shows that the economy has about a 60% chance of contracting within 12 months.

Short-term rates have been higher than longer-term yields, or inverted, before each of the 7 recessions since 1970.

“The adjusted curve is giving a powerful signal for an upcoming U.S. recession,” said Ruslan Bikbov, a fixed-income strategist in New York at Bank of America, one of the 22 primary dealers of U.S. government securities that trade with the Fed.

“If that happens, the Fed’s target rate could remain near zero beyond 2014,” more than a year longer than the central bank has indicated, he said in an interview on October 3rd.

The Inflation Rate Is Only 1.2%? Say What?

"The inflation rate right now is 1.2% for all goods and services."

-Federal Reserve Chairman, Ben Bernacke, in testimony before the U.S. House Financial Services Committee, March 2, 2011.

According to a recent article on CNNMoney.com, the Fed is currently projecting inflation of less than +2% for each of the next 3 years. Really?

The bar chart above shows the change in the price of several commodities from 2000 to 2010. The majority, if not all of which would be considered by many American's to be "staple" items.

For the group as a whole, the average price increase was more than +100% for the 10-year period, which was an annual increase of about +6.5% per year, more than twice the annual inflation increase the U.S. government has been reporting for the same period!

Has the government been under reporting the inflation figures for the past 10 years? Do you believe that inflation is really running under +2%? The government couldn't be misleading us, could they?

Chart of The Day: Reserve Bank Credit Outstanding - Japan vs USA

The USA's Federal Reserve balance sheet credit explosion, which began soaring in 2008, looks ominously identical to Japan's.

The credit explosion was unable to repair the economic malaise in Japan.

Will it work here in the U.S.?

Don't hold your breath...

No Relief for Yet Housing Prices...

The S&P/Case-Shiller Index of Home Values in 20 cities fell -1.6% from November 2009, the biggest 12-month decrease since December 2009, according to the median forecast of 26 economists surveyed by Bloomberg News.

Mounting foreclosures will probably throw more properties on the market this year, further depressing prices, homeowners’s equity and construction.

The lack of a sustained housing rebound and unemployment above 9% are among reasons the Federal Reserve may refrain from raising interest rates and complete a 2nd round of stimulus that could pump $600 billion into the economy by June. 

“The large overhang of unsold houses will weigh on prices,” said Sal Guatieri, a senior economist at BMO Capital Markets in Toronto. “Housing is lagging the economic recovery. It is one factor encouraging the Fed to remain on the sidelines.”

Why Do We Put So Much Blind Faith In The Federal Reserve?

The Federal Reserve released a 3-year forecast for our nation's unemployment rate on 11/20/2007.  

The Fed believed that unemployment would be no higher than 4.9% during calendar year 2010.

As of 12/31/2010, the national unemployment rate was 9.4%.

(source: Federal Reserve, Department of Labor)

Quantitative Easing Explained...

Faith in Government Low...

Steen Jakobsen, Chief Investment Officer at Litmus Capital Partners, says a big risk for markets is the fact that faith in the U.S. government's ability to fight the economic markets, as well as in central banks' monetary policy tools, is eroding.

"The fact of the matter is that people have a huge disbelief in government," he said.  "The real crisis 2.0 is not about the new normal or whatever term is being used, the new crisis is a crisis of faith in the U.S. system. We're far away from that point now but that is a clear risk," Jakobsen said. 

Because people are losing faith in the governments' ability to bring the economy back on track, the impact of various policies is smaller, while keeping interest rates at record lows has altered investors' perception about what this actually means for the market, Jakobsen warned.

Investors no longer perceive low rates as good for stock markets because they create liquidity, but as a sign that a slowdown in economic growth is coming, he said. 

Jakobsen predicts zero or even negative growth for the US economy for the third and fourth quarters.

Whoa! - The Money Supply Explodes +120%!

The money supply has gone parabolic!

In the past year the Federal Reserve has increased the money supply by a whopping +120%. That's never happened before. Recall that in the 1970s the Fed increased the money supply +13% and inflation soared into the double digits.

Gee, I wonder what inflation is going to be like after the money supply more than doubles? 

Now you know one of the primary reasons why:

1. Savvy investors and central banks around the world are exchanging this flood of depreciating dollars for gold, commodities and other hard assets.
   
   
2. India just bought 200 tons of gold and is thinking about buying 200 more.
   
   
3. Gold bullion posted another new high today, closing above $1,200 for the first time!

Chart courtesy of www.StockCharts.com

The Next Shoe To Drop?: Commercial Real Estate Defaults Double

Real Estate Econometrics LLC says commercial mortgage default rate on loans held by U.S. banks more than doubled to 3.4% in the third quarter as vacancies rose and rents declined.

Defaults climbed from 1.37% a year earlier and from 2.88% in the second quarter, the New York-based property research firm said today in a report.

Default rates in the first three quarters of 2009 have been the highest since 1993, the firm said.

“Mortgages originated in 2006 and 2007 are experiencing the most significant shortfalls in current cash flow relative to current debt-service obligations,” Sam Chandan, chief economist of the firm, said in the report.

Federal Reserve Chairman Ben S. Bernanke said in a November 16 speech that “the fallout” for banks from commercial real estate could slow the nation’s economic recovery.

Defaults on bank-owned commercial property mortgages posted the biggest quarterly jump from the previous quarter in six years of FDIC data analyzed by Real Estate Econometrics.