Wednesday, December 28, 2016

An Interest on Interest Rates

The Federal Reserve (known as the Fed), which conduct the monetary policy of the United States, had just announced an interest rate hike of 0.25%, with the possibly of another three more hikes in 20171.

For The Bedokian Portfolio investor, such information is important in the conduct of fundamental analysis (FA). Interest rates belong to the economic conditions category, the highest level of FA, meaning any changes to it will have some effect across some, if not most, financial markets.

The Link Between United States (US) and Singapore Interest Rate

Singapore, unlike the US, does not set its own interest rates. Instead, they are determined by the US interest rates and expectations of the Singapore Dollar’s movement.2 In other words, this means there is a high correlation in direction and movement between the US’s interest rates and Singapore’s. Hence this is the reason why local investors and traders are so interested in what the Fed says about interest rate hikes.

Effects of Higher Interest Rates on Asset Classes

Assuming all things equal, a higher interest rate means higher borrowing costs, which in turn will eat into the profits of companies and REITs, therefore potentially giving a lower dividend yield. Bonds are negatively affected, too, as there is an inverse relationship between interest and coupon rates. Commodities, a non-yielding asset class, would take a beating as well since investors would pull their funds away from them and look for something with more returns. The cash asset class stands to gain from all this, since the rise of interest rates would imply a rise in fixed deposit and savings account interest rates.

So What Now for Bedokian Portfolio Investors?

After almost a decade of ZIRP (Zero Interest Rate Period), the economy and the financial markets are adjusting to the return of this major economic indicator. Your FA should take the points stated in the previous section into consideration when researching on individual equities, REITs and bonds, among other factors. Still, it is imperative to look at your portfolio as a whole and rebalance it according to your preferred asset class allocation, whether you are doing the passive or active approach.

1 – Robb, Greg. Fed raises interest rates and adds another hike to its 2017 forecast. MarketWatch. 14 Dec 2016. (accessed 28 Dec 2016)

2 – Williams, Ann. 10 things you should know about Singapore’s monetary policy. Straits Times. 13 Oct 2015. (accessed 28 Dec 2016)

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