Tag Archives: Interest Rates

Economy, Market News, S&P 500

Economic Policy: Recent Fed Rates Cuts and Their Significance

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Economic Policy: Recent Fed Rates Cuts and Their Significance

The Federal Reserve (Fed) has the responsibility of implementing monetary policy on behalf of the US government by setting interest rates. When interest rates are low, capital is available, which stimulates economic growth. However, if unchecked, low-interest rates may lead to high inflation. High-interest rates create a situation of low money supply, which may cause a recession or even depression.

The Fed is required to maintain acceptable levels of unemployment between four to five percent while restricting inflation to figures around two percent. The Fed achieves this mandate by raising or lowering the fed overnight lending rates (the fed funds rates). At the end of October 2019, the fed decreased the fed funds rate to a target of between 1.5 to 1.75 percent. This is the third cut since July this year.

Why Did the Fed Cut Interest Rates?                    

By lowering the fed funds rate, the Fed aims at stimulating economic growth. The department of commerce has released data for the third quarter that shows GDP growth at a rate of 1.9 percent. Although the figures are better than the market expectation of 1.6 percent, it is a decline from the 2.0 percent growth in the previous quarter. The US growth is on a decline, in the third quarter of 2018, GDP growth was at 3.4 percent. The 1.9 percent growth rate is the slowest in 2019.

The October interest rates cut was more of a precautionary move. A majority of fed committee members believe that the US economy is reasonably strong. The current unemployment rate is the lowest in recent times. Consumer spending performed better than expected. The rates cut is a result of reduced investments and exports due to weakening global growth. The Fed’s decision to cut interest rates is to protect the US economy from the trade-war effects and global slowdown.

Importance of the Fed Funds Rate

The Central Bank of America monitors the performance of the US economy due to its significance to the global markets. Currently, the US is operating on a budget deficit meaning the economy is a net importer. Many countries across the globe depend on exports to the US for stability. Should the US economy underperform, many economies will be hurt. A recession in the US will adversely affect Canada, Mexico, Europe, and many other nations like it did in 2008-2009.

Significant volumes of investment instruments in the financial markets are US dollar-denominated. For this reason, the Fed has to worry about the economy, and by extension, the US dollar. The US dollar is of great importance in international investments and the flow of capital across borders.

Three Funds Rate Cuts: The Performance Connection in Bonds

Historically, three successive interest rates cuts have had positive effects on the performance of the bond market. Between 1995, 1996, and in 1997, there were three consecutive rate cuts and a pause. The S&P 500 returned 24 percent and 19 percent in those years. Where there had been an economic slowdown followed by three rate cuts and a stop, the economy always responds by accelerating. The October funds rate cut was the third in a row. Fortunately, the Fed has no intention of cutting the rates further soon. Going by precedence, the bond market is in line for better returns.

Conclusion

Data from the US economy is not giving a clear picture of the status of the economy. While there has been a decline in GDP growth, unemployment and inflation rates are within their targets. The rate cut will help address declining GDP growth and shield the US economy against the impact of the current trade wars. Bond investors should expect improved yields if history repeats itself.

Market News, S&P 500, Stock Markets

Federal Reserve: Rising Risks for Recession in 2019?

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Federal Reserve: Rising Risks for Recession in 2019?

In the last few months, the financial markets have experienced rising volatility.  This activity has left many consumers on edge and wondering about the best ways to protect their assets.  Recent commentaries from the Federal Reserve have also highlighted a growing possibility that the U.S. economy will experience recessionary conditions as early as next year.  

Not surprisingly, this has already ignited speculation amongst some analysts that the current environment could be causing another financial collapse similar to what was seen during the 2008 financial crisis.  

Of course, much of this speculation is still premature as growth numbers throughout the U.S. remain robust and consumer spending levels are firmly above those which characterized the periods following the credit crunch a decade ago.  But there are still factors which households and individual consumers should consider when making plans for investment or spending money as part of a daily routine.

Effects of Interest Rates and Rising Consumer Costs

In all of the chatter (which has drawn similarities between the financial environment of 2008 and the financial environment of 2018), many people have neglected the ways higher interest rates could impact economic growth —at both the micro and macro levels.  

But this might turn out to the most critical factor which has changed the market this year. The prospect of higher interest rates can have a major impact on the economics of the stock market and this type of activity has already cost investors a great deal of money with respect to this year’s investment returns.

Additionally, higher interest rates can make large purchases more expensive for households.  For example, mortgage lending rates have risen to their highest levels in years and similar trends can be seen in the costs associated with the ability to buy a new automobile.  

For those that are able to buy a home or a car outright, these types of scenarios have limited impact on spending practices. But the majority of households and consumers do not fall into this category and this means that an environment of rising interest rates will have a very real impact on the financial health of most people.

U.S. Economics: Focusing on What Matters

For all of these reasons, it is important for us to focus on what matters and it is never a good idea to dismiss the underlying trends which are being developed by the Federal Reserve.  These are concepts which might seem to be abstract and esoteric. But this could not be further from the truth, as steadily rising interest rates have a very real impact on the ways we structure our long-term purchases.

Since the continued prospects of higher interest rates make large purchases more expensive, it might make sense to complete some of these purchases before the rate cycle reaches its maximum peak.  So, for example, if a family is considering putting off the purchase of a new home until next year, it might actually make more sense to speed-up the timeline and consider alternative options sooner.  

Stock Markets: Long Term Economic Trends

In the long run, these types of decision planning practices can have a substantial impact on the monthly payment and total costs which are required of us. Most financial decisions which are made quickly and impatiently tend to cost more over the long-term, and when we make too many of these decisions it is all too common to see the final outcome rest in bankruptcy.

This is why macroeconomic changes matter and the daily fluctuations in the financial news headlines usually do not matter (at least, not as much).  With this in mind, consumers can probably look past the speculation that a financial collapse is around the corner. But this does not imply the economy “without risk” is an accurate depiction of the current landscape.

Market News, S&P 500

Financial Stocks and Federal Reserve Monetary Policy

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Bank of America: Financial Stocks and Federal Reserve Monetary Policy

  • The financial sector is rallying strongly, and Bank of America is leading the pack higher.\
  • But all eyes are on US President Donald Trump in his next selection for leader of the Federal Reserve.
  • These rallies could be at risk depending on the outcome, and shareholders in BAC could be some of the most deeply impacted if certain monetary approaches are favored in Trump’s selection.  

Stock markets continue to push in their upward surge and some of the strongest names over the last three months can be found in the financial sector.  Leading the pack higher in Bank of America Corp (BAC), which is a stock that we originally bought on the drop to $15 in a trade that is now showing profits of roughly 75% (not including dividends).   

The stock recently experienced the major range breakout that we were expecting, and investors that are long the stock will now need to gauge the likely monetary policy direction that is likely to be taken by the Federal Reserve as a means for understanding how to position going forward.  This is a factor that is more likely to influence financial sector trends more than any other single element in the equation, and Bank of America could be used by the market as a proxy for expressing any significant changes in the outlook.  

Stock Trade Ideas

Our stance is to remain long BAC but with the understanding that adjustments might need to be made if a move dovish monetary policy stance is signalled by Donald Trump’s next selection for leader of the Federal Reserve.

On a year-to-date basis, Bank of America has soundly outperformed the market with stock gains of nearly 26%.  We can compare this to the SPDR S&P 500 ETF (SPY), which has moved higher by only 15% for the period even though the broader environment has been characterized by optimism over tax reform and a pro-growth agenda for the US economy.  

Global Interest Rates

The disconnect here is significant, as it underscores the majority expectation for higher interest rate into 2018.  There are valid arguments in both direction with respect to whether or not these initial expectations have actually been satisfied.  But the real questions here lie in the monetary policy direction that will be undertaken by the Fed once its new leadership regime takes control.  

Currently, markets are dealing with three possibilities as Fed Chair (John Taylor, Jerome Powell, or the continuation of Janet Yellen in her current position).  There are very different implications here depending on which economist is ultimately selected, and those long BAC will almost certainly feel the resultant volatility in their positions over the next few weeks.

BAC Earnings Data: Yahoo Finance

Higher interest rates generally make it easier for banks to drive revenues and improve margins, but the policy course that has been taken by Janet Yellen has been far more dovish than many analysts initially anticipated.  We have seen conflicting commentaries from US President Donald Trump with respect to his assessment of Yellen’s approach to the economic recovery.  

But, over time, it has started to look as though Trump does favor this supportive stance as it is more likely to drive consumer spending and help stock markets maintain their record highs.  But, at the same time, Trump has shown an interest in appointing more hawkish names (i.e. Taylor and Powell).  

Fed Policy Direction

On the spectrum from most dovish to most hawkish, this list of possibilities moves from Yellen to Powell to Taylor and so the ultimate decision here will likely determine the trading tone that is seen for most of the first half of next year.  For BAC bulls, Taylor would likely lead to the most favorable outcome and this is important given the areas of weakness that were seen in Bank of America’s earnings report for the third quarter.  

Earnings of 48 cents per share did beat the market expectation of 45 cents (confirming the longer-term trends) but revenues were more erratic at $22.079 billion (also confirming the longer-term trends).  Trading revenues remain the central cause for concern, as annualized revenues from fixed-income trading fell a substantial 22% for the period.  

Bank of America Chart Analysis

This has put some cracks in the foundation, and the rallies in BAC could be at risk if the market if not convinced that the next Fed chief is ready to aggressively tighten policy in ways that match normalized historical trends. Given Trump’s recent comments, it would not be entirely surprising to see something of a “compromise verdict” where the US President selects Jerome Powell as Fed Chair and then appoints John Taylor in a secondary role at the central bank.  

Anything short of this is likely to lead to selling pressure in BAC.  Readjustments in our long position will be considered if an unfavorable outcome sends share prices back below 23 as it would suggest another period of consolidation that cannot be fully mitigated by the stock’s 1.73% dividend yield.  Until then, we will hold our positions and collect the dividend while the momentum is still positive.