The Federal Reserve’s tightening would affect conditions from capital flow to housing markets. As an investor making decisions about your personal finances, you want to know how the potential changes will affect your investments. The Federal Reserve “makes money tight” by raising short-term interest rates, which increases the cost of borrowing. Expensive borrowing leads to less borrowing. Here’s what you need to know.
The Value of the Dollar
The dollar has been rising, and it will likely continue to rise as the Fed tightens the economy. The strengthening dollar is a result of the United States showing better GDP growth than most other developed markets and even better than many emerging markets. For investors, the strong dollar means that you may want to consider keeping most of your fixed-income investments in U.S.-based assets.2
Consumer Interest Income
Fed tightening should boost consumer interest income more than consumer interest expense. Consider how your investments will be affected by higher short-term interest rates, especially your CDs and Money Market funds.
Generally speaking, equity markets initially swoon after fed tightening but appear to weather rate hikes well. The initial swoon is caused by adjustments that must be made as U.S. dollar funding sources dry up.
Emerging market countries usually compete for liquidity by raising their own rates, and this causes slowdowns. Some market sectors weather rate hikes better than others.3 For example, materials and info technology stocks generally perform better than utilities and health care during tight monetary policy periods.4
Emerging market’s assets are vulnerable to tightening, but not all EM assets are equally vulnerable. India, Turkey, and Brazil seem to be more vulnerable than Russia, Korea, and China. If you are heavily invested in EM assets, you may want to make adjustments under tighter monetary conditions.4
Bonds usually beat stocks with rising interest rates, but that’s not always the case, and U.S. stocks are currently not far below their all-time peak prices. Since differences in future returns depend chiefly on how inexpensive stocks are at the present, a rise in interest rates could be a boon for long-term investors.5
Historically, the period of time right before a rate hike is a great time to invest. In fact, over the past 6 tightening periods since 1980, the S&P 500 has averaged returns of 23.5% in the 9 months prior to the first rate increase.6 Continue to look after your future by working with your financial advisor to invest wisely and manage the gains you’ve made over the years.
For more information about investing during a fed tightening period, or for any other investing concern, contact us at WrapManger. One of our Wealth Managers will be happy to help you.
4. JP Morgan Market Insights