Today’s FOMC policy statement is a lot likely to announce the beginning of the Fed’s tightening cycle. Fed Chair Janet Yellen and other top officials from the central bank have repeatedly indicated that the time is right to raise rates. Employment targets have more or less been achieved. Inflation has been a worry for some time, but the recent jump in CPI is an indication that the tide is turning.
A rate hike will have a varying impact on different sectors of the economy. While some of them, like the financial sector are likely to benefit, others like REITs await the announcement with much trepidation.
Commodities
Once the Fed hikes rates, the dollar is widely expected to move upward. This will make dollar-priced oil costlier for those making purchases using other currencies. Market watchers believe that this will be detrimental to crude prices.
Even though both Brent and WTI prices increased on Tuesday, they moved lower on Wednesday. As of 11:01 GMT, Brent lost $1.08 cents per barrel and was at $37.37 while WTI crude futures declined 29 cents to $37.06 per barrel. Oil stocks have rebounded recently with sector heavy weights Chevron CVX and Exxon Mobil XOM gaining 3.4% and 0.7%, respectively, over the last five days.
Gold prices have declined 10% over last year primarily because of an imminent rate hike. However, they have bounced back from their lowest point in six years over this month. This is because investors began focusing on the exact timing of the rate hike and the quantum of future price increases. But the year-long decline in gold prices has continuously weighed on share prices of gold mining stocks. Over the last five days, Barrick Gold ABX and Newmont Mining Corp NEM have lost 12.2% and 10.1%, respectively.
Financials
Meanwhile, banks and insurers are set to gain from the rate hike. Banks gain from a steep yield curve, i.e. when the spread between long-term and short-term rates is wide. The interest rates on deposits are typically tied to short-term rates while loans are often tied to long-term rates. Thus, the potential rise in rates will allow the banks to charge more for loans, leading to an increase in the spread between lending rates and the rates paid on deposits.
Insurance stocks benefit the most from a rate hike. That is because insurance firms must match up assets (bonds) with their liabilities (policies), so higher rates mean more investment income. With more income and similar policy payouts, insurance companies witness an improvement in margins, making them top picks in a rising rate environment. Tri-Valley Bank TRVB, Avesis Inc. AVSS, County Bancorp, Inc. ICBK and Erie Indemnity Company ERIE have gained 40.7%, 26.3%, 25.5% and 7.6%, respectively.
REITs
REITs own and operate income-producing real estate. They are required to distribute at least 90% of their taxable income to shareholders annually in the form of dividends and can in turn deduct the payout from their corporate taxable income.
This is why a rate hike might not usher in good news for the heavy debt-dependent sectors like the utilities and REITs. A rate hike would essentially imply more borrowing costs for them. This class of securities has high dividend payers whose yields become less attractive when the rate of interest increases.
Among the residential ETFs, United Development Funding IV UDF, Starwood Waypoint Residential Trust SWAY and Bluerock Residential Growth REIT, Inc. BRG have lost 50%. 8.6% and 7.7%, respectively, over the last four weeks in anticipation of the upcoming rate hike.
Retail
The Fed will hike rates only on the basis on visible improvement in the domestic economy. This comes as good news for retail companies that should benefit from consumers wishing to spend more. On the other hand, consumers have been circumspect recently, with retail sales increasing only 0.2% in November. Meanwhile, the savings rate has crept up, indicating that many buyers are building up nest eggs.
However, a rise in interest rates will hit both the margins and top lines of leading retailers as it will dampen consumer credit expenditure. It will also mean that retailers will find it tougher to service debt which will hit margins. Over the last five days, Macy’s M and Nordstrom JWN have lost 8.6% and 0.5%, respectively, while Wal-Mart Stores Inc. WMT has remained largely flat.
Autos
For the first time since the recession, auto sales are expected to come in over the 17 million mark. The low interest rate regime has proved beneficial to the sector. Meanwhile, the resurgence of the wider economy and falling gasoline prices have also boosted automotive purchases.
A rate hike would make auto loans costlier and certainly have an impact on sales, albeit a limited impact on the sector. Mark Scarpelli, president of Raymond Chevrolet and Kia has said he believes that a higher interest rate regime will lead to a 2% decline in sales over the next two years. Even so, it may be a good idea to watch the likes of General Motors GM and Ford F closely as the rate hike is announced.
Limited Impact?
A section of market watchers believe that the rate hike will ultimately have a limited impact, that too in the short term. This is because the market has already priced in a rate hike given the ample signals provided by the Fed over a long period that such a move is in the offing. Even so, the world will watch with bated breath as the Fed takes a widely awaited decision today.
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