Tail Of The Put – Financial Review

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DOW – 117 = 17,603
SPX – 15 =2063
NAS – 42 = 5065
10 Y – .01 = 2.30%
OIL – 1.07 = 36.80
GOLD – 7.90 = 1062.10

I was away on vacation on December 16th when the Fed raised interest rates, so I want to start today by going back and taking a look at what that really means and how it might affect the economy and the markets moving into the New Year. First, let’s be clear; the Fed did not raise rates on December 16th; the Fed raised their target for the fed funds rate, which is the rate at which banks lend to each other. That’s a technicality.

The Fed will buy and sell securities to increase the cost of borrowing money across the banking system. So money is becoming more expensive for all financial institutions. And the banks and financial institutions then pass along those cost to their customers in the form of higher interest rates. Short-term and long-term rates will move higher, at least in theory, but in reality, they don’t always move higher in lockstep.

And the dollar should get even stronger as rates move higher on Treasuries and corporate bonds. The reason is simple; if you are a foreign investor and you want to buy debt that offers a higher rate you first have to trade whatever currency you have for dollars to make the purchase; that raises demand for the dollar causing the price of the dollar to go up or get stronger. Also, many investors will take money from stocks to buy bonds that offer a higher rate, so money tends to flow out of the stock market.

Higher rates mean savers should get more return on their saving, but higher rates also mean borrowers face higher debt service; in other words, mortgages, auto loans and credit card debt will all cost more. Again, not everything moves in lockstep, so the banks tend to raise their lending rates quickly but they are slow to raise the rates they pay out on deposits.

And because the cost of borrowing goes up, consumers tend to spend less, at least for purchases that involve borrowing. And if people buy less, the companies that make the goods or provide the services tend to cut back and invest less on expanding their businesses or hiring new workers.

Again, it doesn’t always play out in a clear, linear pattern; the US economy has changed, and the service sector is about 3 times larger than the manufacturing sector. You might need to take out a loan to buy a car but you pay cash for a hamburger, so rate hikes may have less impact on the labor market than in the past.

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Author: Travis Esquivel

Travis Esquivel is an engineer, passionate soccer player and full-time dad. He enjoys writing about innovation and technology from time to time.

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