(Image credit: Day Donaldson, via Flickr)
It has been a story of “will they or won’t they” this entire year.
We are talking of course, about interest rates. The last rate hike in December 2015 was the first since 2006, and gradual hikes were expected in 2016 but the Federal Open Market Committee (FOMC) has ended every meeting so far with the decision to maintain interest rates. Market watchers are at the edge of their seats. The consensus is that a rate hike is looming and it could come as soon as November or December, when the FOMC next convenes.
In preparation for that, here are three things that you should know about a potential interest rate hike.
Will Markets Cheer or Jeer?
Here is a look at how the market has reacted to FOMC decisions lately:
*Prices plotted based on the adjusted close price of the last day of each month
Lately, markets seem to breathe a sigh of relief whenever rates remain unchanged but it is really anyone’s guess as to how the market will react to the next rate hike.
There are reasons why the market could react positively or negatively. Markets could jeer, as higher interest rates mean heftier borrowing costs for companies and consumers. In other words, it could be a drag on the economy. But markets could cheer as well because a hike may mean that the US economy is back on track and that the FOMC is confident enough to remove its crutches.
How Did We Get Here in the First Place?
Interest rates are practically zero as of this moment. The graph below shows how interest rates have fallen to this point over the years:
In the 1980s, to combat double digit inflation and the residual effects of the 1980 energy crisis, interest rates were hiked to about 20%. It stands in stark contrast to our current low interest rate environment. This low rate was a result of the global financial crisis; the US economy was hit hard by the crash in the housing market and banking sector from 2007 – 2009 and interest rates were reduced so that consumers and businesses could continue to spend and boost the economy. Interest rates have been kept low ever since as the FOMC has adopted a wait-and-see approach.
What Investors Should Take Note Of
There are two sectors that investors should keep an eye on – property and financial institutions.
It is easy to see why financial institutions will be affected. Their core business revolves around loans and their performance varies with interest rate levels. As for the property sector, it could go both ways. Higher mortgage rates make home buying more expensive, but the FOMC’s decision to raise rates could signal a healthy economy and a healthier economy could buoy the housing market.
And it isn’t just the US market we are talking about here. As money moves back to the US seeking higher interest rates, in a bid to stay competitive, interest rates in other countries may be increased as well. So do your research and pencil in these dates: 1-2 November 2016 and 13-14 December 2016. The market will be holding its breath as the FOMC convenes to decide whether the time has come to finally hike interest rates.
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