You’d be hard pressed finding a pundit who doesn’t think the Fed will raise rates in the US next month. If you take the market as a guide, a rate rise of 0.25% has already been priced in.
And that was before the results of the US presidential election were announced.
Trump’s proposed cuts to both personal and company taxes, along with his massive $1 trillion ‘road and bridges’ infrastructure plan, have raised the prospects of inflation breaking higher once he is sworn into office.
On top of the proposed huge spending on infrastructure, wages in the US are finally crawling upwards after going nowhere for nearly two decades. A ramp up in wages — albeit from a low base — will only add more pressure to inflation. This, too, will push the case for an increase in rates.
Of course, there’s no ‘sure thing’ in the markets. We’ll find out either way when the Fed announces its decision on 14 December, less than one month from now.
With the volatility we’ve seen over the last 12 months — including the reaction to both Brexit and Trump’s victory — it’s easy to forget that the Fed raised the cash rate in December last year.
And can you remember the reaction? The Dow Jones index had a massive dummy spit, dropping close to 2,000 points over the following month or so.
Such a massive reaction — more like overreaction — wasn’t off the basis of a single interest rate rise. It’s more to do with the fear of what’s coming after it. Interest rate movements, both up and down, tend to move in cycles.
In Australia, since October 2011, the RBA has cut the cash rate 12 times in this current cycle; 11 times by 0.25%, and a one-off 0.50% cut in May 2012.
The previous, post-GFC cutting cycle saw the RBA move quickly and aggressively, dropping the cash rate from 7.25% in September 2008 to just 3% in April 2009. That was an unprecedented move in a period of only eight months.
But what is often less well remembered is that, after hitting the 3% level in April, it only took another six months before rates started to rise again. From October 2009, the RBA raised rates six times over seven months, and increased one more time in November 2010, to 4.75%, which marked the top of the rate rise cycle.
And that’s what the market fears. That a rate rise by the Fed in December could be followed by a number of quick and regular rate hikes after that. An increase in rates redirects money out of equity markets and back into bonds.
That’s also why the most anticipated part of the Fed announcement won’t be the actual move in rates (if they decide to move). It will be the commentary that comes with it that will move the market.
A ‘softly, softly’ approach could provide some impetus for the stock market. But any indication of a more aggressive stance will test the current euphoria that has followed Trump’s success.
Nobody knows how many of Trump’s proposals will come to fruition. There is precious little detail on how this massive infrastructure spend will be financed — whether privately, or by an infrastructure-style bank.
For the rest of the world, though, central banks continue to sing from the same hymn sheet. They continue to see the world economy growing at sub-par levels, and anaemic wage growth — a big determinant of inflation.
And as the RBA governor has previously noted, one of the key limitations of wage growth is structural. Free trade agreements and similar pacts have pushed jobs offshore to lower-wage countries.
Protecting US jobs — and returning jobs back ‘home’ — was a key pitch in Trump’s election campaign. Markets will be watching particularly closely to see if, and how, this will be implemented.
Any tariffs imposed (or increased) on imports can lead to a trade war — something that no country wins in the end. If such a thing was to occur, it would also prove bad for the economy and keep interest rates lower.
For income-focused investors, though, the issues will remain the same. It will take a huge increase in rates before investments like term deposits become attractive again. They will still need to look for yield-based investments to supplement their income.
A lot of yield-based stocks have sold off over the last couple of months in anticipation of a cycle of rate rises. After also being hit by the selloff, a stock like Telstra [ASX:TLS] is trading on a current yield of 6.6%, fully franked. That’s still around triple what you’ll get in a term deposit.
If the Trump ‘jump’ runs out of puff, the market could quickly rediscover these stocks after being sold off so heavily.
That’s why, over at Total Income , I’ve been spending so much time uncovering tomorrow’s most likely top income earning stocks. The goal is to get in before the mainstream gets onboard…before these companies’ share prices surge, and your potential returns head south. You can learn all about how to do that here.
Editor, Total Income
Editor’s Note: This article was originally published in Markets and Money.
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