Rate Hikes on The Horizon: Phoenix Direct Management Review

The main objective of central bankers is to moderate economic fluctuations. Their first priority is keeping inflation low, reflecting slow and steady economic growth; second is reducing unemployment. Central banks use monetary policy to control liquidity, making cash more or less available in an attempt to meet their goals. Liquidity includes cash, money market instruments and credit, which is comprised of bonds, mortgages and loans.

When the economy is slow and unemployment is high, central banks will increase liquidity. They are essentially printing money out of thin air. Home buyers are happy because their mortgage payments drop but this devalues the purchasing power of money and when not held in check is a great scam perpetrated on private people by governments.

A strong economy is reflected by lower unemployment and rising prices. Higher prices also erode purchasing power which is why inflation needs to be controlled. Central banks do so by reducing the supply of money. One of the ways they do this is by raising interest rates.

According to Former Fed Chair Janet Yellen, the official target of the U.S. Federal Reserve is 2% inflation. The Fed raised rates three times last year. Analysts were projecting another 3 raises for 2018 but as Bloomberg reports, the current Chairman Jerome Powell will likely have a fourth raise.

Affect On individual investors

Investment Advisors at Phoenix Direct Management report that the biggest concern for clients right now is how to prepare themselves for rising interest rates. Stock markets have been extremely volatile during the first quarter of the year, and investors need to brace themselves for ongoing fluctuations. Periodic volatility is healthy for markets and provides the ideal opportunity for clients to review their investment plan and balance sectors in their portfolios where they may be over or under weight. Advisors will have different advice for each investor depending on their stage in life and personal investment objectives but there are some general common sense tips for coping with interest rate risk:

  1. This is the time to rebalance investment portfolios. Reduce sectors that are overweight and holdings that are sensitive to rising interest rates, like utilities and preferred stocks.
  2. Invest in precious metals. The price of gold moves in tandem with interest rates, along with silver and platinum. Investment options include bullion, mutual funds, stocks and derivatives. Large cap mining stocks are best for most portfolios.
  3. Strengthen undervalued sectors that are less sensitive to interest rate increases, like consumer stocks.
  4. Investors approaching retirement can consider selling their homes. Rising rates negatively impact real estate, and provide better returns when the proceeds are reinvested in income generating fixed income products.
  5. Younger investors should take this opportunity to increase their savings habits and lower their credit card debt.

Interest Rates and Currencies

Global capital flows to where it gets the best return, given an appropriate amount of risk. The Federal Reserve Board is closely followed because the US Dollar is the world’s reserve currency and its movements affect all other currencies on a relative basis. Currency trading averages more than $5 Trillion USD per day, the equivalent of an entire month of trading on the NYSE. When analyzing interest rate risk, financial professionals and economists take in to account projected monetary policy affecting the currencies that dominate international trading. The most important currency is the U.S. Dollar, with five others dominating international currency trading.

The Euro

The Euro is the second most held reserve currency in the world, and represents the second largest market after the United States. Monetary policy for the European Union is set by the European Central Bank. The Euro has been appreciating since the beginning of the year. Interest rates are expected to stay low in the short term, with a hike projected by mid-2019.

The Japanese Yen

The Yen is important for two reasons. First, Japan is one of the largest economies in the world and secondly, the Yen is considered a ‘safe haven’ investment. The central bank in Tokyo has no current plans to increase interest rates. They will continue with their quantitative easing policies until they achieve their target of 2% inflation. Rate increases would strengthen the Yen against the dollar and slow trade.

The British Pound

The Pound Sterling, as it is officially named, will continue to be volatile. The uncertainty surrounding the Brexit issue will eventually settle which is bullish, countered by recent reports of lower than expected inflation reports. Rates will remain low with the next hike likely in May. The Pound, which was the world’s reserve currency prior to the USD, accounts for 5-10% of daily currency and CFD trading.

The Australian Dollar

The USD:AUD is one of the most active trading pairs in forex markets. Interest rates in Australia and New Zealand are higher relative to the countries of the other major trading currencies, yet these two countries are stable economically and politically. Just the way in times of uncertainty money flows to safe havens, when things are more stable, money flows to the Ozzie and Kiwi dollars to grab some extra return. Higher interest rates in the U.S. will attract money away from Australian markets. The Reserve Bank of Australia is expected to hold rates steady in the short term.

The Canadian Dollar

The Loonie, as the Canadian Dollar is known, ranks 6th for most held reserve currencies. It is strongly affected by commodity markets, particularly the prices of oil and gold. It trades off the USD and is an alternative play for forex traders. Interest rates are expected to rise 3-4 times during 2018, however Canadians carry enormous debt so rises should be minimal.

Big picture review

Interest rates are more predictable than currency market fluctuations, both of which affect global stock markets. Investors with a solid investment plan and a well-diversified portfolio can expect positive returns over the coming year. Understanding what is happening in the world and preparing oneself for bumps in the markets help investors to avoid unnecessary stress, being susceptible to scams and poor decision making.

About Phoenix Direct Management

Phoenix Direct Management Tokyo invites existing clients and interested parties to contact their office in Tokyo, Japan to review their holdings and answer any questions, and remind everyone that the only stupid questions are the ones not asked.  

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