Win Inspite of Fed’s Hike?

It is a Bond trader’s market, this hike season.

The second time this year and a third time after the crisis, the Fed raised interest rates by 25 basis points. The reason was to limit rising inflation. There are hopes of the economy stabilising after the tableau of unemployment and low productivity. Unemployment rates have dropped and the economy is predicted to perform better. It is forecasted that prices would rise only gradually and predictably, and so any significant changes would immediately be spotted in order to respond adequately on time. Raising of interest rates has been proposed as a better solution than waiting till the last minute and raising rates rapidly, which would cause a shock to the economy, disrupting financial markets and pushing the economy into recession, yet again. It is expected that Fed will raise the rate at least twice this year, but progressively.

Although this move is quite the opposite to Trump’s plans to cut taxes and raise spending, it may be the answer to the economic situation in the US. An economic growth of 2.1 percent was predicted this year, in comparison with 1.9 percent in 2016. This may not be entirely possible, given that the economy would soon reach a cyclical peak; Also, China’s slowdown would adversely affect the global economy and thus the US economy. On the other hand, although the US economy is growing, and the stock market touched record highs, investments are low. Businesses are not exactly on the verge of investing. Nobody wants to rush. This is the case in point. Businesses must invest, as levers of economic growth. They are presumably responsible for stalling or aiding the economy. Forecasts depend on businesses and their investments, to reach the 2 percent rise in economic growth.

In any case, this rise in interest rates has immediately decreased yields on government bonds, while it has increased average yields in the stock market, as expected. If interest rates increase faster than expected, then investors would prefer short-term bonds, while contrarily, when interest rates grow gradually in the condition of low inflation and a slow economy, then longer-term bonds would have higher demand.

Historically, the 10-year yield fell to 2.15 percent, while two years ago, during the last hike,  the yield was at 2.27 percent. Obviously, lower level of inflation than forecasted showed that Fed’s decision did not have the desired effect, especially because inflation had been below the central bank’s target. However, this decline also showed that the bond market did not agree with the Wall Street’s consensus for the 10-year Treasury’s yield of 2.7 percent. This is primarily connected with expected gradual rise in interest rates. While long-term rates are falling, short-term traders are aligned with the Fed’s projections.

However, since the Treasuries are very attractive financial products when inflation is minimal, while yields are low globally, there are purchases. For example, China has bought many of them and is preparing for new purchases when the yuan stabilizes. This, of course, affects the global financial market. The future remains unpredictable, as long-term yields are affected by many factors, and not just interest rates.  Global economic conditions are not promising either, especially because of China’s economic slowdown. Nevertheless, now is also a good time to buy short-term stocks, although one can never predict another recession, though there are no signs of it in the current cycle.

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