Federal Reserve Rate Hike: Who Wins, Who Loses, Who Goes Meh
©2015 Bloomberg News
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(Bloomberg) — Janet Yellen and the Federal Open Market Committee have finally taken the world’s biggest economy off life support. Now, U.S. government deficits will rise, insurance companies will get relief and savers — who’ve weathered years of earning next to nothing — will continue to survive on crumbs.
The rate hike comes as no surprise, but it’s new territory nonetheless. Investment bankers, traders and analysts who were in business school back in December 2008 when then-Fed Chairman Ben S. Bernanke began the journey known as ZIRP, for zero- interest-rate policy, are now in their 30s, their entire careers spent in what current Fed Vice Chairman Stanley Fischer called “far from normal” times.
The rate hike comes as no surprise, but it’s new territory nonetheless. Investment bankers, traders and analysts who were in business school back in December 2008 when then-Fed Chairman Ben S. Bernanke began the journey known as ZIRP, for zero- interest-rate policy, are now in their 30s, their entire careers spent in what current Fed Vice Chairman Stanley Fischer called “far from normal” times.
Here are some winners, some losers and some who won’t be much affected by the Fed’s “liftoff”:
WIN: Other central banks
The Bank of Japan, the European Central Bank and the People’s Bank of China are pumping more money into their economies. The Fed’s tightening will put those efforts on steroids, said Carl Riccadonna, Chief U.S. Economist for Bloomberg Intelligence.
Winners will be countries “with low inflation who are large exporters to the U.S.,” he said.
LOSE: Federal budget
The U.S. government could pay as much as $2.9 trillion more in interest over the next 10 years if rates slowly escalate, according to calculations by the Congressional Budget Office and Dean Baker, co-director of the Center for Economic and Policy Research in Washington.
MEH: Savers
Rates on savings accounts and certificates of deposit accounts are likely to improve, allowing consumers to generate more interest on the cash they’ve parked at the bank.
At the same time, what Christopher Whalen, senior managing director at Kroll Bond Rating Agency, called the “huge wealth transfer from savers to debtors” over the last seven years will probably continue. Returns on money market funds, longtime havens for retirees and others on fixed incomes, have cratered to near-zero from 4.79 percent in October 2007, before the financial crisis, according to Crane Data. Savers will likely be the last to benefit from higher rates.
WIN: Long-Term Treasuries and Corporate Bonds
Corporate pension managers were waiting for higher rates to buy debt since higher yields make it easier to match their income to what they’ll need to pay pensioners, said Anthony Gould, head of global pension solutions with JPMorgan Asset Management.
Pension plans and retirement funds should buy $68 billion of fixed-income assets next year, according to strategists at JPMorgan Chase & Co. Combined with the $1.1 trillion other institutions will buy, demand could outstrip supply by $100 billion next year, they said.
LOSE: Brazil, China
As if political scandals and a deepening recession aren’t enough, the interest-rate rise will weaken the real, giving an unwelcome push to Brazil’s inflation, which is 10.5 percent and rising.
As for China, “debt is still increasing at twice the pace of the economy,” said Ruchir Sharma, head of emerging market equities at Morgan Stanley Investment Management. “That’s not a sustainable model.”
Come to think of it, trying to squeeze out 7 percent annual growth in the middle of the world’s biggest borrowing binge might be tough to overcome with or without a Fed hike.
MEH: Banks
Under the Fed’s record-low rate, banks were limited on what they can charge on loans and earn on other investments. So lending margins have plummeted, revenue growth has stagnated and overall earnings have suffered. Now banks will be able to charge more.
But higher rates can also have a negative effect on banks’ earnings if the interest lenders have to pay to depositors rises faster than what they’re charging on loans. And since banks have varying businesses mixes, not all of them will see the same effects from rising rates, leaving analysts guessing about which banks will see the biggest gains.
“On paper, the banks look leveraged to rising rates, but history raises some key questions,” said Sanford C. Bernstein & Co. analyst John McDonald. The timing and effects of rising rates on banks “remains a key debate that will likely rage on for much of 2015 and beyond.”
WIN: Insurance companies
Since they invest customers’ premiums with the aim of being able to cover losses with the profits, insurance companies hated ZIRP. U.S. property-casualty insurers are earning an average annualized yield of 3.1 percent on investments, the lowest in half a century.
That will improve, albeit slowly, as the Fed raises rates, said Doug Meyer, an analyst at Fitch Ratings.
“It’ll have an impact over time, a favorable impact on earnings across virtually every product line,” Meyer said.
LOSE: Automakers
Liftoff would reduce demand for new vehicles by about 150,000 units, or about 1 percent of the market, over the next 12 months, according to a J.D. Power poll of 2,301 Americans planning to purchase a vehicle in the next 12 months.
Dealers and automakers would likely reduce prices, increase incentives or subvent interest rates to boost demand, said David Sargent, J.D. Power vice president of global vehicle research.
“A lot of the effect in the short term is probably going to be psychological rather than practical,” Sargent said.
MEH: Commodity prices
Boom and bust cycles in commodities are decades in the making, so the rate hike will have little effect on price declines, said Robert Stimpson, a fund manager at Oak Associates Ltd. in Akron, Ohio, which manages about $900 million.
In other words, don’t blame Yellen.
WIN: The Fed
Good economic news! The national jobless rate is at its lowest in seven years and economic growth has surpassed expectations. Not that Yellen ought to don a flak jacket and declare mission accomplished, but the first rate hike since 2006 is a sign that at least the ATMs will continue spitting out twenties when Americans need them. That was an open question when rates went to near-zero in 2008.
LOSE: The Fed
Too late! That’s the opinion of Paul Mortimer-Lee, BNP Paribas SA’s chief economist for North America.
“The die may already be cast and the path to the next recession may have been taken,” Mortimer-Lee told clients in a report last month. “The reason for our recession concern is not so much because of what the Fed is about to do — likely embark on a slow hiking cycle beginning in December — but because it did not start the tightening much sooner.”
MEH: The Fed
Monetary policy has already tightened! While the Fed dithered, markets did it on their own.
Goldman Sachs Group Inc. tracks that sort of thing with its Financial Conditions Index, a measure that incorporates variables like stock prices, credit spreads, interest rates and the exchange rate. Though the bank says it’s a rough estimate of conditions, it also says that every 1 percent rise in the Fed funds rate shows up as a 1.5 percent increase in the index.
The index rose to its highest level in five years before the Fed policy makers met on Sept. 17. The index has hovered near that peak since, equating to a Fed hike of 75 percentage points.
WIN: Other central banks
The Bank of Japan, the European Central Bank and the People’s Bank of China are pumping more money into their economies. The Fed’s tightening will put those efforts on steroids, said Carl Riccadonna, Chief U.S. Economist for Bloomberg Intelligence.
Winners will be countries “with low inflation who are large exporters to the U.S.,” he said.
LOSE: Federal budget
The U.S. government could pay as much as $2.9 trillion more in interest over the next 10 years if rates slowly escalate, according to calculations by the Congressional Budget Office and Dean Baker, co-director of the Center for Economic and Policy Research in Washington.
MEH: Savers
Rates on savings accounts and certificates of deposit accounts are likely to improve, allowing consumers to generate more interest on the cash they’ve parked at the bank.
At the same time, what Christopher Whalen, senior managing director at Kroll Bond Rating Agency, called the “huge wealth transfer from savers to debtors” over the last seven years will probably continue. Returns on money market funds, longtime havens for retirees and others on fixed incomes, have cratered to near-zero from 4.79 percent in October 2007, before the financial crisis, according to Crane Data. Savers will likely be the last to benefit from higher rates.
WIN: Long-Term Treasuries and Corporate Bonds
Corporate pension managers were waiting for higher rates to buy debt since higher yields make it easier to match their income to what they’ll need to pay pensioners, said Anthony Gould, head of global pension solutions with JPMorgan Asset Management.
Pension plans and retirement funds should buy $68 billion of fixed-income assets next year, according to strategists at JPMorgan Chase & Co. Combined with the $1.1 trillion other institutions will buy, demand could outstrip supply by $100 billion next year, they said.
LOSE: Brazil, China
As if political scandals and a deepening recession aren’t enough, the interest-rate rise will weaken the real, giving an unwelcome push to Brazil’s inflation, which is 10.5 percent and rising.
As for China, “debt is still increasing at twice the pace of the economy,” said Ruchir Sharma, head of emerging market equities at Morgan Stanley Investment Management. “That’s not a sustainable model.”
Come to think of it, trying to squeeze out 7 percent annual growth in the middle of the world’s biggest borrowing binge might be tough to overcome with or without a Fed hike.
MEH: Banks
Under the Fed’s record-low rate, banks were limited on what they can charge on loans and earn on other investments. So lending margins have plummeted, revenue growth has stagnated and overall earnings have suffered. Now banks will be able to charge more.
But higher rates can also have a negative effect on banks’ earnings if the interest lenders have to pay to depositors rises faster than what they’re charging on loans. And since banks have varying businesses mixes, not all of them will see the same effects from rising rates, leaving analysts guessing about which banks will see the biggest gains.
“On paper, the banks look leveraged to rising rates, but history raises some key questions,” said Sanford C. Bernstein & Co. analyst John McDonald. The timing and effects of rising rates on banks “remains a key debate that will likely rage on for much of 2015 and beyond.”
WIN: Insurance companies
Since they invest customers’ premiums with the aim of being able to cover losses with the profits, insurance companies hated ZIRP. U.S. property-casualty insurers are earning an average annualized yield of 3.1 percent on investments, the lowest in half a century.
That will improve, albeit slowly, as the Fed raises rates, said Doug Meyer, an analyst at Fitch Ratings.
“It’ll have an impact over time, a favorable impact on earnings across virtually every product line,” Meyer said.
LOSE: Automakers
Liftoff would reduce demand for new vehicles by about 150,000 units, or about 1 percent of the market, over the next 12 months, according to a J.D. Power poll of 2,301 Americans planning to purchase a vehicle in the next 12 months.
Dealers and automakers would likely reduce prices, increase incentives or subvent interest rates to boost demand, said David Sargent, J.D. Power vice president of global vehicle research.
“A lot of the effect in the short term is probably going to be psychological rather than practical,” Sargent said.
MEH: Commodity prices
Boom and bust cycles in commodities are decades in the making, so the rate hike will have little effect on price declines, said Robert Stimpson, a fund manager at Oak Associates Ltd. in Akron, Ohio, which manages about $900 million.
In other words, don’t blame Yellen.
WIN: The Fed
Good economic news! The national jobless rate is at its lowest in seven years and economic growth has surpassed expectations. Not that Yellen ought to don a flak jacket and declare mission accomplished, but the first rate hike since 2006 is a sign that at least the ATMs will continue spitting out twenties when Americans need them. That was an open question when rates went to near-zero in 2008.
LOSE: The Fed
Too late! That’s the opinion of Paul Mortimer-Lee, BNP Paribas SA’s chief economist for North America.
“The die may already be cast and the path to the next recession may have been taken,” Mortimer-Lee told clients in a report last month. “The reason for our recession concern is not so much because of what the Fed is about to do — likely embark on a slow hiking cycle beginning in December — but because it did not start the tightening much sooner.”
MEH: The Fed
Monetary policy has already tightened! While the Fed dithered, markets did it on their own.
Goldman Sachs Group Inc. tracks that sort of thing with its Financial Conditions Index, a measure that incorporates variables like stock prices, credit spreads, interest rates and the exchange rate. Though the bank says it’s a rough estimate of conditions, it also says that every 1 percent rise in the Fed funds rate shows up as a 1.5 percent increase in the index.
The index rose to its highest level in five years before the Fed policy makers met on Sept. 17. The index has hovered near that peak since, equating to a Fed hike of 75 percentage points.
–With assistance from Sonali Basak, Matthew Boesler, Joseph Ciolli, Simon Kennedy, Betty Liu and Jennifer Surane.
To contact the reporters on this story: Alexandra Scaggs in New York at ascaggs@bloomberg.net; Elizabeth Dexheimer in Washington at edexheimer@bloomberg.net To contact the editors responsible for this story: Boris Korby at bkorby1@bloomberg.net; Peter Eichenbaum at peichenbaum@bloomberg.net Bob Ivry
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