/perspectives/global-cio-outlook/what-the-fed-s-rate-hike-means-for-investors

What the Fed's Rate Hike Means for Investors

Historically, both equities and fixed income have performed solidly in the initial years of Fed tightening cycles.

December 17, 2015

The Federal Reserve made history Dec. 16, finally raising the fed funds target range by 25 basis points to 0.25-0.50 percent after seven years at the zero bound. We anticipate a gradual pace of tightening, though not quite as gradual as the market is currently pricing in. We expect three 25 basis point hikes in 2016 and another three in 2017, with the next hike likely to occur at the March 2016 Federal Open Market Committee meeting. Our analysis suggests the terminal rate in this cycle will be in the range of 2.5–3.0 percent, below the Fed’s estimate of 3.5 percent, which should help to keep 10-year Treasury yields under 3 percent.

 


 

 

If history is a guide, equities typically experience an initial pullback of 5–10 percent in the months following the first rate hike in a tightening cycle. Historically, though, the S&P has ultimately performed well during recent tightening cycles, returning a cumulative 15 percent, on average, in the first two years of the last three tightening cycles. That being said, current valuations temper our return expectations—the ratio of U.S. equity market cap to GDP is near its historical peak, buoyed by historically low rates.

S&P Sectors Generally Positive Two Years From First Rate Hike

Average Cumulative Two-Year Total Return Following Start of Last Three Tightening Cycles

Emerging Market Valuations Look Attractive, but Risks Remain

Source: Bloomberg, Haver Analytics. Data as of 11.19.2015, based on the last three tightening cycles beginning in February 1994, June 1999, and June 2004. ©2015, Guggenheim Partners.

 

Fixed-income investors should also benefit—leveraged loans stand out as having delivered strong returns with much less volatility than the S&P 500 and Treasuries, on average, during previous periods when short-term rates were rising. Leveraged loans returned 5.8 percent on average in the first year of the last three Fed hiking cycles, higher than the S&P’s 4.9 percent. We believe the recent selloff in high-yield credit presents an attractive buying opportunity that will ultimately prove rewarding for patient investors.

U.S. Equity Market Has been Inflated by Low Rates

Ratio of U.S. Equity Market Cap to GDP vs 10-Year Treasury Yields Since 1960

Emerging Market Valuations Look Attractive, but Risks Remain

Source: Haver Analytics, Federal Reserve, Guggenheim Partners. Data as of 9.30.15. ©2015, Guggenheim Partners.

Economic Data Releases

Leading Economic Indicators Climb in November as Homebuilding Picks Up

  • In the 12 months through November, headline inflation rose 0.5 percent. Core inflation was up 0.2 percent from October. The annual core inflation rate quickened to 2 percent from 1.9 percent in October.
  • The index of U.S. leading economic indicators increased 0.4 percent in November, aided by an increase in home construction permits and higher stock prices. Economists had forecast an increase of 0.1 percent.
  • The latest Empire State Manufacturing Survey indicated a further decline in business activity in December. However, the pace of decline slowed from the previous month.
  • The pace of homebuilding in November increased 10.5 percent on the previous month. Building permits ticked up by 11 percent in November from October to an annual pace of 1.289 million.
  • Industrial output slipped 0.6 percent in November after a downwardly revised 0.4 percent decline in October. Economists had forecast industrial production slipping by 0.2 percent.
 

Euro Zone Data Points to Solid 4Q Performance as U.K. Unemployment Continues to Fall

  • The Euro Zone Manufacturing Purchasing Manager’s Index (PMI) rose to 53.1 from 52.8 in December, a 20-month high. The services PMI fell to 53.9 from 54.2.
  • Industrial production for October increased 0.6 percent month over month in the euro zone. This contrasted to a decline of 0.3 percent in September.
  • December’s reading of the German ZEW index of current economic sentiment came in at 55, ahead of economist’s expectations of 54.2 and a November print of 54.4. The expectations index increased to 16.1, up from 10.4 in November.
  • The Ifo Institute Index of the German business climate fell to 108.7. Economist had forecast no change the November print of 109.0.
  • At 0.1 percent year over year, the rate of inflation in the United Kingdom turned positive in November for the first time in four months.
  • The U.K. unemployment rate fell to 5.2 percent in the three months to October, a post-financial-crisis low.
  • On a year-over-year basis, Japanese exports fell 3.3 percent in November, versus expectations for a 1.6 per cent decline.

FEATURED PERSPECTIVES

June 17, 2019

Managing While Risk Premia Shrink

The Federal Reserve’s policy pivot has supported a rally in most credit sectors, but investors should worry about late cycle excesses.

May 23, 2019

U.S.-China Trade War: The New Long March

Beijing is preparing for a protracted standoff as the U.S.-China trade war ramps up.

May 17, 2019

Quantifying the Credit Risk and Default Runway

After the recession starts, high-yield bond and bank loan issuers have at least a 12-month runway before we experience a large wave of defaults.


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