The Federal Reserve did not raise interest rates last week. Here is how that decision is playing out:
- Interest rate sensitive securities have rallied – long duration, investment grade bonds especially, but also utilities and real estate investment trusts. This is because their coupons remain attractive in a low interest rate, low inflation environment.
- Commodities have plunged – miners[i], energy companies, industrials, and railroads. The Federal Reserve stating lack of inflationary pressures obviously isn’t helpful for commodities producers or transporters. Even worse, very low interest rates allow marginal companies to continue to service their debt and stay in business. This keeps energy and commodities mired in a state of over-production such that prices remain low and even the best-run firms are much less profitable.
- Financial services companies have declined. Most of these firms benefit from a wider spread between short and long term interest rates. They had performed well in September in anticipation of a rate hike, but have given back all of those gains today.
- The dollar sank right after the report. This has been beneficial to foreign currency funds, especially emerging market sovereign debt. One of the biggest losers has been hedged foreign equity funds like DXY and HEDJ, because they are losing on both the stock side (weaker global growth means lower stock prices) and the currency side. Theoretically, non-national resource based emerging markets (think India or Hong Kong) should do better relatively since dollar weakness takes pressure off their currency and commodity price weakness is a net positive.
Lower for Longer
There seems to be near universal agreement that the Fed would either move in September or December. Currently, futures markets give only a five percent chance of a move at the next meeting in six weeks. Therefore, tactically there is time to adjust portfolios to take advantage of the factors cited above. Goldman Sachs put out a report a week or so ago title titled “Lower for Longer”. That may be the phrase that everyone adopts for the next several weeks.
Alternatively, the patient investor may look at the sell-off and say thank you for giving me the opportunity to invest in the “rates are ultimately going higher” scenario at lower prices. Clearly, energy, financial services, and railroads had been moving up in September anticipating higher rates. Depending on the data we see in October and November (and what happens in China), the same kind of activity may take place leading up to the mid-December Fed meeting and ultimately be rewarded.
A Technical Perspective
There is no other way to look at last Thursday’s afternoon’s rally, subsequent failure, and Friday’s sell-off as the stock market tried to break overhead resistance and failed. The implication is that the trend toward lower prices is re-confirmed.
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[i] This is true only of base metal miners. Precious metals miners are up on dollar weakness and the belief that the Fed will not lift rates until it is too late to stop an outbreak of inflation.