Federal Reserve Chair Janet Yellen and her team of central bankers sit down Tuesday for the start of a two-day policy setting meeting.
While Wall Street largely expects the Fed to keep monetary policy on hold, analysts will be watching the meeting statement released on Wednesday afternoon for clues about the timing of the next interest rate increase.
A Fed on hold could be good news for stock investors in the short term. “This could set the stage for a nice rally in the U.S. stock market,” says Colin Cieszynski, chief market strategist at CMC Markets in Toronto.
“Positive economic figures of late like nonfarm payrolls, retail sales and industrial production point to a positive environment for corporate earnings while the Fed is in neutral,” he says. “And there’s potential for more stimulus from abroad that could give the markets a boost in the coming weeks.”
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Analysts will closely examine this week’s Fed policy statement release. The tone of concerns about effects of Brexit will be important to watch, says Jennifer Vail, head of fixed income at U.S. Bank Wealth Management in Portland, Oregon.
“If heightened concerns continue, we believe that would lead to reduced probability of an interest rate hike in 2016,” she says.
Ernie Cecilia, CIO of Bryn Mawr Trust, in Bryn Mawr, Pennsylvania, says investors should watch for any change in the “gradual” language as it relates to future rate hikes. That will be a key factor that the markets focus on, Cecilia says.
After this week’s meeting, Fed officials are scheduled to hold three more policy meetings this year: Sept. 20-21, Nov. 1-2 and Dec. 13-14. Many analysts discount the November date as a “live” meeting, noting the central bank may not want to set an interest rate increase just before the U.S. presidential election in an attempt to maintain a politically neutral appearance.
Vail says she expects the Fed to hike interest rates at the December session. “There is a lack of material impact on the domestic economy from Brexit risk, and the current levels of GDP growth, employment and inflation do not justify a nearly emergency level of monetary policy,” Vail says.
The benchmark Fed funds interest rate currently stands at 0.25 to 0.50 percent, still well below a more historically normal range of 3.50 to 4 percent.
Others agree the December meeting is ripe for interest-rate action. “I think the Fed will raise rates once in December after the election,” Cieszynski says. “I think they will try to stay on hold until then, but if they wait any longer, they risk getting behind the curve on inflation. The longer they wait to start again, the more aggressive they may need to raise rates later on.”
What does this mean for investors now? Major investment narratives will change once the Fed hikes again, especially if the increase is interpreted as the beginning of a major rate hike cycle, says Henry To, partner at Newport Beach, California-based CB Capital Partners.
“This means investors will need to make significant changes to their asset and sector allocations,” To says.
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As expectations remain high that the Fed will raise rates this year and potentially in 2017, here are six money strategies investors can consider:
Stay diversified. Maintain a portfolio of high-quality investments — both equities and bonds, Cecilia says. When looking at individual stocks, look for companies with strong balance sheet metrics as well as strong return on invested capital, Cecilia says. “Stocks of more leveraged enterprises would be negatively affected by higher borrowing costs,” he says.
Shift stock sector weightings. Once the Fed begins to hike, interest rates should rise across the board, especially if U.S. inflation starts to surge, To says. “This means investors who have been overweighting the consumer staples, telecom, utilities and real estate sectors should now underweight them and re-allocate to other sectors instead,” he says. “In such a scenario, minimum-volatility funds should also underperform, as they are heavily invested into the consumer staples and utilities sectors.”
Consider beefing up exposure to financial stocks. U.S. financials have historically done well during a Fed rate hike cycle, To says. “This should be especially true in this cycle given how far U.S. financials and the U.S. yield curve have fallen since the beginning of this year,” he says. “One ETF that I like is the Vanguard Financials ETF (ticker: VFH), which tracks the performance of the MSCI U.S. Financials index. Its holdings consist of stocks such as Wells Fargo (WFC), JP Morgan (JPM), Berkshire Hathaway (BRK.A, BRK.B), Bank of America (BAC) and Citigroup (C).”
Look at your mortgage interest rate. Mortgage rates remain extremely low. But these products are tied to the 10-year Treasury note yield, which is expected to rise later this year, especially if the Fed hikes rates. Homeowners should consider refinancing their mortgages now at a fixed rate to lock in the lower levels, Cecilia says.
Seek products that benefit from rising rates. One example of a specific investment that would benefit from a rising rate environment is floating-rate bond funds, To says. “These funds hold securities whose yields will adjust higher when short-term interest rates rise,” he says. “One example is the iShares Floating Rate Bond ETF (FLOT), which tracks the investment returns of a portfolio of U.S. dollar-denominated, investment-grade, floating-rate bonds with maturities between one month and five years.”
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Reduce exposure to bonds. The U.S. bond market has been in a long-time bull market, To says. “With the U.S. inflationary pressures now ticking higher and with the Federal Reserve poised to hike rates again next year, investors should seriously think about reducing their fixed income exposure,” he says. “Investing in bonds haven’t been this risky since the 1970s.”
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6 Smart Investing Moves to Make as the Fed Meets originally appeared on usnews.com
